We choose not to fight a determined central bank and see further upside to CAD against JPY and NZD. Currency markets have been trending over the last few weeks with the primary driver being a hawkish shift in stance from the ECB, BoE and BoC causing global rates to jump. We will assess the CAD from a longer-term perspective and attempt to identify potential short-term dislocations that we can use as trading opportunities.
Deputy Governor Wilkins triggered a CAD rally on the back of the BoC’s hawkish shift and a weaker USD as markets remain sceptical about the Fed’s tightening plans.
Pre-BoC meeting hawkish rhetoric from BoC members resulted in rates markets aggressively pricing in ~90% probability of two hikes by October and ignited a CAD rally. Governor Poloz emphasised the central banks shift in focus to addressing financial stability risks giving less weight to current inflation readings while remaining upbeat on an accelerating economic recovery with a closing output gap which should lead to higher wages and inflation. BoC are looking to take back excess accommodation in an attempt to cool a hot housing market. Governor Poloz and Deputy Governor Patterson also downplayed CAD bears primary arguments by acknowledging that:1. oil prices are low however,they have been catered for in central bank forecasts and 2. NAFTA is a risk but will be addressed when more information is known.
In line with market expectations the BoC hiked rates on Wednesday. The Governing Council (GC) acknowledged the comprehensive economic recovery noting the rate of job creation and positive business sentiment allowing the GC to conclude the output gap is expected to close by the end of the year. A more hawkish than expected tone resulted in further CAD strength.
Markets will be watching Canada’s CPI print on Friday. We are leaning towards a lower than expected read given last weeks soft US CPI figures and CAD CPI correlation with US CPI. If we see a soft print it is unlikely the BoC trajectory will change and we would use a CAD pullback as an opportunity to enter long CADJPY and short NZDCAD.
From the CAD side we see no point fighting a determined central bank and see room further out on the curve to price a steeper path that will provide a boost to CAD.We see the BoJ remaining dovish given they have endured a prolonged period of low inflation which will limit the amount of lenience the central bank will show towards inflation figures. Although Japan has a tight labour market, there is still limited wage growth mainly due to structural economic changes. The BoJ will remain dovish and are unlikely to change their Yield Curve Control policy soon. Yield differentials should drive this pair higher however the risks to this trade is if risk sentiment deteriorates strengthening the JPY or there is a drop in yields globally.
The foundation for our bearish NZD view is 1. NZD tends to underperform when global yields rise, 2. we see the RBNZ remaining on hold and 3. long NZDUSD positioning is stretched. The risk to this trade is if NZDUSD breaks through the 0.74 handle.