The Canadian Dollar is a Sell ahead of Wednesday's BoC Statement says RBC

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- CAD enters big week vying with GBP for No.1 spot in G10. 

- RBC says sell CAD ahead of BoC as it could shift to "neutral".

- CIBC warns of "short-covering" after BoC as "too early" to shift.

- TD looks for CAD weakness on uncertainty over BoC outlook.

The Canadian Dollar is vying with Pound Sterling for the top spot in the G10 universe for 2019 but that could all change this week if analyst commentary on the Loonie is anything to go by, given many are warning clients that losses are looming on the path ahead. 

RBC Capital Markets told clients Tuesday to bet against the Canadian Dollar this week while other Toronto-headquartered financial firms including CIBC Capital Markets and TD Securities have a mixture of projections about the likely outcome from this week's Bank of Canada (BoC) meeting.

"The BoC is universally expected to leave rates unchanged this week, so all focus will be on the statement, MPR and press conference. Our economists look for a shift to neutral on forward guidance, a cut to 2019 growth forecasts and a potential downward revision to the Bank’s estimate of neutral (currently 2.5-3.5%)," says Adam Cole, chief FX strategist at RBC. 

Cole has advocated that clients buy the USD/CAD rate this week in anticipation of a return toward and then above the 2019 range-high, which is located at 1.3450, playing out in the wake of Wednesday's Bank of Canada interest rate decision. USD/CAD was quoted at 1.3366 during morning trading Tuesday.

The Bank of Canada already gave a taste back in March of what may be to come on Wednesday when it told markets "the outlook continues to warrant a policy interest rate that is below its neutral range," after having decided to leave its interest rate unchanged at 1.75%.  

Last month's statement was part of an ongoing u-turn by the BoC on its forward guidance, which had suggested in October that  interest rates could rise as many as three times in 2019, potentially taking the cash rate up to 2.5%. This would've been the lower bound of the estimated 2.5%-to-3.5% 'neutral range' where  policy is thought to be neither stimulative nor restrictive.

The Bank of Canada began to abandon its hawkish interest rate guidance in December and is still distancing itself from it today, after a slowdown in the global economy led North American central banks at the Federal Reserve and BoC to fear blow-back that would ultimately hurt their own growth prospects. Since then both the U.S. and Canadian economies have began to slow, prompting analysts to question whether earlier estimates of the 'neutral range' were too high in both countries. 

Above: USD/CAD rate shown at 4-hour intervals, capturing 2019 price action and 1.3450 range high.

"A soft Business Outlook Survey and continuing uncertainty in housing and consumption are likely to hold more weight with GovCo than last week’s firm inflation. Much of this is expected which limits the impact, but we think the risks to CAD are asymmetric – so we’re going long USD/CAD this week (the alternative would be to do it in o/n vol as the breakeven is unusually low)," Cole writes, in a note to clients. "USD/CAD’s dip lower on Monday gives a slightly better entry level."

Cole says the BoC will shift into 'neutral' this week, which could see it all-but claim that no further hikes will be forthcoming this year. The BoC has raised its cash rate five times since the summer of 2017, in increments of 0.25%.

The BoC could even go as far as warning that the next move in its cash rate could be either up or down, which might encourage the market to begin preparing for rate cuts further down the line. But it might also stop short of saying its rate hiking cycle is over. 

Pricing in the overnight-index-swap market currently implies a Canadian cash rate of 1.68% by year-end, which is below the current actual rate of 1.75% and suggests that investors are already betting to some extent that the BoC will cut rates before the curtain closes on 2019. 

Those bets could grow larger this week, weighing on the Canadian Dollar in the process, or they could remain unchanged if the Bank leaves some hope in the market that rates might rise before the year is out. 

Interest rate decisions are normally only made in relation to the outlook for inflation but impact currencies because of the push and pull influence they have over capital flows and due to the opportunity they provide short-term speculators. But inflation is sensitive to changes in economic demand as well as the supply of goods, which means developments in the economy over the coming months will be key to the outlook for the Loonie.

Above: USD/CAD rate shown at daily intervals.

The USD/CAD rate was quoted 0.27% higher at 1.3382 Tuesday and has now fallen -1.53% this year, while the Pound-to-Canadian-Dollar rate was 0.57% higher at 1.7421 and has risen 0.12% in 2019. 

Both Sterling and the Loonie are vying with each other for first place in the G10 league table and what will matter most for the outcome of this competition is the performance of the GBP/USD rate relative to CAD/USD. 

If Sterling rises faster against the U.S. Dollar than its Canadian rival, or falls by a lesser extent, the Pound-to-Canadian-Dollar rate will cling to its 2019 gain and the British currency likely retain the number one spot for the G10 universe. 

Above: Pound-to-Canadian-Dollar rate shown at daily intervals.

"The Bank will aver that there are other headwinds holding the economy back, making stimulative interest rates an appropriate setting, and the neutral rate of less relevance," says Avery Shenfeld, chief economist at CIBC. "Our view is that the simple fact that rate sensitive sectors like housing and durable goods sales are in a funk tells us that current rates aren’t in fact stimulative." 

Shenfeld and the CIBC team say this week's meeting will largely be about semantics and that the market may not read the BoC's statement in the same way that they do. CIBC projects some "short-covering" will follow the BoC statement as it's "too early" for the bank to risk stating that its hiking cycle is over. It's still possible that economic growth and inflation will rise later in the year, which would then risk forcing another u-turn at a later date.

They project the BoC will lower its estimate of the neutral rate but only by a fraction, which will enable Governor Stephen Poloz to claim that rate policy is still "stimulative" and that it's other "headwinds" that are dampening growth, even if in reality, the BoC's past rate hikes are already acting as a handbrake on the economy. In other words, CIBC says the BoC will remain "patient" and "data-dependent" this month. 

"They simply can’t be that assured that the pace of growth will improve enough for the economy to weather higher rates. A revised estimate of the output gap that will show some slack as a cushion against accelerating inflation will also lean in that direction," Shenfeld writes, to clients. "None of this will be enough to have the Bank offer up any hints of the rate cuts ahead."

CIBC says the USD/CAD rate could fall this week but not by enough to persuade the bank to take a bet on it, especially as Shenfeld and the FX team's forecast is for the exchange rate to sit at 1.34 come year-end 2019. TD Securities is less optimistic in its outlook for the Loonie this week as the bank is also looking for another break above 1.34 by the USD/CAD rate.

"The softer outlook for GDP certainly implies a more cautious approach than in January – the only question is whether the March statement went far enough to reflect the realities facing the BoC," says Andrew Kelvin, a strategist at TD Securities. "Given the broad disappointment on growth in 2018Q4 we don't see a likely path back to full employment for the BoC this cycle. It would therefore be appropriate for the Bank to signal that they have no firm conviction on the direction of the next move in the overnight rate." 

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