CAD: BoC to remain a bullish factor in the medium-term
Markets are fully pricing in a 50bp rate hike, and attaching a 25-30% implied probability to a 75bp increase. Looking further down the CAD swap curve, however, market pricing does not look excessively aggressive on the hawkish side, as the expected year-end rate is around 2.68% at the moment.
We think the chances that the BoC will hike rates to 3.0% before the end of 2022 are quite elevated, which suggests that – unlike elsewhere in the G10 such as the eurozone or UK – there is some sizeable room for further hawkish re-pricing in rate expectations in Canada. Ultimately, this factor – along with the rate advantage itself – is a bullish argument for the loonie in the medium run, and we continue to see BoC tightening as a contributing factor to pushing USD/CAD below 1.25 in the second half of the year.
Looking at the shorter term, we think only a 75bp hike next week will be able to materially lift the loonie, considering a 50bp move is fully priced in. That said, a scenario where the BoC hikes by 50bp but delivers hawkish hints on more 50bp increases and on the terminal rate should be enough to put a floor under CAD next week.
At the current juncture, USD/CAD dynamics remain strictly tied to swings in global risk sentiment. We’ll likely need to wait for a sustained stabilisation in sentiment before we can see USD/CAD re-align with its fundamentals (rates, commodities, and growth stories), which point to a stronger CAD. With market instability possibly extending into the summer, USD/CAD may stay close to the 1.27-1.28 area, gearing up for a break lower in the latter part of the year.
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