The Canadian Dollar is Bought after BoC Stokes Loonie's Fire, but Uncertainty Lingers

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- CAD recoils on GBP, USD following remarks from BoC's Poloz

- Poloz says policy "about right" after ditching similar claim in Oct.

- Fireside comments come after Wilkins-inspired sell-off in CAD. 

- Wilkins said it's "better" to put winter tires on before snowfall.

- BoC rate setters may be divided, U.S.-China talks key to outlook.

The Canadian Dollar advanced against the Pound and U.S. Dollar Thursday after Bank of Canada (BoC) Governor Stephen Poloz used an eagerly-awaited speech to relight the Loonie's fire in the wake of an earlier sell-off. 

BoC Governor Stephen Poloz is reported to have told an audience at the Ontario Securities Commission that current Canadian interest rates are "about right", according to a Reuters report, barely more than a month after the bank omitted a similar and oft-repeated claim from its latest policy statement. Contents of the speech were neither televised nor made public in the usual manner by the BoC, although some newswires had reporters present on site. 

"Today's comments reinforce our tactical bias for USDCAD to trade lower. We look for the post-Wilkins rally to be unwound and estimate FV closer to 1.3150," says Mazen Issa, a senior FX strategist at TD Securities. "While this speech is not as dovish as some expected, we do not think his message is entirely inconsistent with the October MPR."

Above: Pound-to-Canadian-Dollar rate shown at hourly intervals alongside 2-year CA Gov bond yield (orange line, left axis).

Poloz's comments came after Deputy Governor Carolyn Wilkins prompted a fierce sell-off in the Canadian Dollar when she told the International Finance Club of Montréal that "you want to put the winter tires on before the snow falls. It not only protects you, but also everyone else who’s on the road." The remark was interpreted as a hint that she'd rather cut the cash rate before the nascent global slowdown arrives on Canadian shores, instead of waiting until after. 

Wilkins said Canada's economy is in a good place but that the global economy is "facing immense challenges" including the trade war, which risks flaring again into year-end. She also floated "large-scale asset purchases," widely seen as a byword for a currency-crushing 'quantitative easing' program, as an option for fighting any economic downturn that might materialise in future years. 

"We think Poloz's fireside chat and his reference that monetary conditions are "about right" is a notable one as far as the CAD is concerned. It suggests that there is no particular urgency for the Bank to ease soon," Issa says. "we expect the irrational exuberance post-Wilkins speech this week to be unwound. The 1.33 level in USDCAD looks increasingly like a top. The 200dma just below the figure will be an important pivot that we expect to break near-term."

Above: USD/CAD rate shown at daily intervals with 200-day moving-average (200 DMA) in orange. 

Changes in interest rates are normally only made in relation to expected movements in inflation but can have a significant influence over international capital flows as well as speculative short-term trading activity. Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.

The BoC abandoned in October its regular assertion that the current level of Canadian interest rates is "appropriate" before warning that the economy's resilience would be tested in the months ahead by a downturn in the global economy and trade-war-related woes in the manufacturing sector. Just like on Thursday, the bank said back then it would monitor the extent that the slowdown spreads beyond manufacturing and business investment, with a particular focus on consumer and household spending.

Poloz and colleagues have bucked the trend among peers this year, leaving rates unchanged at 1.75% even as the Federal Reserve and others cut in order to fend off the disinflationary global slowdown. Omitting the claim that rates are "appropriate" in October was seen as a hint that a cut could be on the horizon, but markets hadn't really taken the bank seriously until after Wilkins' speech.

"We expect USDCAD to remain rangebound in the near-term. Looking into Q1 2020, however, we expect there to be sufficient evidence of waning domestic fundamentals on the back of the global deceleration to warrant a 25 bp ease by the Bank. As that’s not currently being priced in by markets, the move should see the C$ weaken modestly, with USDCAD hovering around 1.33 and 1.34 in Q1 and Q2 of next year, respectively," says Taylor Rochwer, an economic analyst at CIBC Capital Markets. 

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

The overnight-index-swap market implied Thursday morning, a January 22 cash rate of 1.59%, down from 1.63% before Tuesday's speech from Wilkins but still above the 1.5% that would prevail after a cut. That implied rate will move up and down in the weeks ahead in response to economic data, statements from BoC policymakers and developments in the U.S.-China trade talks - likely taking the Canadian Dollar with it on each occasion. 

Canada's Dollar had already begun to stabilise in the wake of Wilkins' earlier comments and was aided in doing so by resilient inflation figures on Wednesday. The Loonie is the best performing major currency for 2019 off the back of the BoC's steady rate policy, which has its roots in the earlier resilience of the domestic economy although a change in that rate policy would put that crown at risk. And such change, or losses for the Loonie, could well play out against an improved backdrop for Sterling.

"Our base case scenario is for the Conservatives to gain a majority in the upcoming election, though it could be by a tight margin. Furthermore, given that we expect progress to be made on the Brexit process next year, that should see Sterling rally towards highs reached in May. However, given the imminent election, expect Sterling bulls to remain contained in the near-term," says Jeremy Stretch, European head of FX strategy at CIBC.

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