(Jing Ren – Orbex)
The BOC has taken an even more aggressive rate hike route than the Fed, giving the CAD the fastest rising rate of the majors. This didn’t stop the meteoric rise in inflation that most developed countries have been seeing this year, although not as dramatic as in the US. Given the economic interconnectivity with the US, it’s not surprising that CPI trends have been similar in both countries.
However, unlike in the US, Canada has been seeing not only a flattening but actual downturn in core CPI, the measure followed by central banks. This opens the question whether the BOC’s increased frontloading of the interest rate means they can slow the pace of hikes before other central banks. Particularly as more economists worry that there is a recession on the horizon, if it’s not already here. If core rates continue to fall, there would be further arguments for the BOC to not “lead” the Fed higher. The BOC meets again in late October.
What to look out for
Canada’s inflation rate is expected to fall for the second consecutive month to 7.3% from 7.6% prior. This is expected to be supported by a -0.1% monthly rate, compared to 0.1% in July. The figures mirror the results seen in the US, but at a lower level. The drop in global crude prices has contributed to a reduction in energy costs in Canada as well.
But what the BOC focuses on is the core rate, which trims off the effects of energy and food prices. And there the situation is a little more complicated, since annual core CPI is expected to rise to 6.2% from 6.1% prior. This is based on an expected acceleration in the monthly measure to 0.6% from 0.5% in July.
Putting the pieces together
Just like with the US’ data from last week, even if the headline inflation rate goes down, the market is likely to react to the core rate. However, the differences that could impact the market here are really small. If the core rate is in line with expectations, it’s just a decimal away from the prior. And a variation of a couple of decimal points from expectations is quite common.
If the rate were to be at 6.1% or above, it would likely lead to speculation that the BOC will keep its aggressive stance. Because it suggests that a downward trend in the core inflation rate has not been established yet. This idea could get an extra boost later this week if the Fed raises rates by 100bps, which could lead to speculation that the BOC might raise rates by a full percentage point again.
What if expectations aren’t met?
On the other hand, a miss of expectations by just two decimals (or more) would signal that the downward trajectory in inflation is intact. That could return the discussion to how much the BOC will moderate its tightening at the next meeting. And, again, this could be further supported if the Fed hikes by just 75bps on Wednesday.
As for the Canadian dollar, weakness has been attributed to the expectation that the BOC will “pivot” first. But if headline inflation is coming down, while core inflation signals the BOC will remain aggressive, the upward trend of the USDCAD could get interrupted. Of course, the situation could be reversed if inflation signals the BOC could take a breather in the steep rate climbing.
Why patience may pay in this market
(Giles Coghlan LLB, Lth, MA – HYCM)
Since the start of the month we have increasingly seen hopes of a Fed ‘soft landing’ gain traction as US stocks made another run higher. However, hopes of a soft landing were dashed by Tuesday’s US CPI print which came in firmer than expected and once again raised the prospect of a Fed needing to hike aggressively in order to tackle stubborn inflation. Stocks quickly erased a few days of steady gains and found near term support at obvious daily support. Look at the Dow, Nasdaq, and the S&P500 below:
The Fed meeting
The Fed meet next week and we are now in the blackout period. That means we will not hear from the Fed until the decision on Wednesday evening. Does that mean we will see USD strength into next week? Most likely as the market is in a USD buying bias and even higher rates will not only favour US rate differentials, but safe haven flows may boost the USD as well. The disorderly moves in the stock market, and volatility rising, on the hot CPI print can certainly generate more USD interest.
The medium term bias is so uncertain
This is the tricky bit. Where is the global economy heading? Is this latest US inflation print a one off return to a high reading or is inflation going to be stickier? Is Ukraine’s push back of Russian troops going to accelerate a potential peace deal between Russia and Ukraine? Can the Fed manage a soft landing after all and will the coming rate hikes be enough to cool inflation without hitting the US economy too hard? Can China manage to rebound this year by getting both Covid under control and supporting its struggling property sector? Will surging energy prices keep economies struggling? The list could go on, but in markets like these it is generally best to be patient. If you want to pick a medium term bias, that is fine. However, just make sure that your risk is carefully managed and you have accepted the risk.