Next week’s Bank of Canada meeting is arguably too soon to see a rate cut from Governor Poloz, but swap markets have aggressively priced in a greater than 50% probability on Friday afternoon alone.
Risks are still skewed towards an insurance style rate cut in Canada given the slowdown in economic activity in Q4 2019 threatening to spill over into Q1 coinciding with a downturn in the global economy due to the coronavirus.
Despite the risks, which are only rising by the day as more data filters into markets, we believe the timing of the next BoC meeting will be too premature to expect a chance of a rate cut despite markets front-running expectations of further easing by central banks across the board.
Governor Poloz has some wiggle room, which markets are pricing into their expectations.
- Firstly, the true extent of the coronavirus damage is yet to be gauged with only confidence indicators and manufacturing PMIs released thus far for the February period.
- Secondly, disentangling the data to analyse the domestic economic forces, which are arguably more structural and impactful to the BoC’s medium-term outlook, in February from the impact of the coronavirus isn’t a trivial task.The impact of the coronavirus, which is likely to be siphoned through the current account and business sentiment, could soon be reversed given the right co-ordinated stimulus package globally.
- Finally, with oil markets cracking below $50 the loonie is now trading at a substantially weaker level at $1.35. Currency weakness has been a favoured tool of Poloz’s in order to stave off calls for pre-emptive rate cuts as it buffers the current account from external headwinds.
Taken together, market pricing looks about right for next week’s BoC meeting.
April’s meeting is now more likely to see a rate cut than not in our opinion. This highlights a marked turnaround in our thinking as we held a long-standing conviction call of no rate adjustments since early 2019. Should this scenario play out, the narrative of the BoC lagging the Fed’s rate cycle would reappear.
That being said, a 25bp rate cut in April at this moment in time is not a foregone conclusion; the same cannot be said for the US.
Oil markets could show signs of recovering back above the $50 mark, which would temper fears of an entrenched economic slowdown in Canada’s economy.
This hinges not only on OPEC+ production cuts being announced in the March meeting but also an increase in compliance from Russia.
Additionally, stimulus measures from key trading partners could also trim expectations of a rate cut in April if they are deemed to be successful and deep enough to restore global growth back to the pre-virus trend.
Although, we are sceptical this stimulus package will take effect prior to April’s meeting.
Author: Simon Harvey, FX Market Analyst at Monex Europe.