Canadian Dollar Bought for Sterling at RBC with Fed and Bank Stocks Cited
- Written by: James Skinner
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"For now we are positioned with short GBP/CAD on an expectation that US 2y rates end the week higher in yield (CAD dragged up as mini-USD proxy) but that if we don’t and we see renewed bank turmoil, GBP starts to suffer as a bank stock proxy" - RBC Capital Markets.
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The Canadian Dollar rose against a softer Pound on Tuesday but RBC Capital Market says it could push GBP/CAD back to early February lows if the Federal Reserve (Fed) revives the U.S. Dollar this Wednesday or if there is any further turmoil in the banking sector of the stock markets.
Canadian Dollar exchange rates were a mixed bag of performances on Tuesday when GBP/CAD slipped further after Statistics Canada said inflation had fallen in what was a far better February outcome for the Bank of Canada (BoC) than that expected by many economists.
The consensus had looked for the main inflation rate to fall from 5.9% to 5.4% but it actually fell to 5.2%, while the core inflation rate was expected to ease from 5% to 4.8% but declined further to 4.7%, suggesting that Canadian price pressures are moving in the right direction for the BoC.
"That together with narrowing breadth of inflation pressure suggests persistent easing in fundamental price pressure, which should be enough to keep the BoC on hold through the end of this year," says Elsa Lignos, global head of FX strategy at RBC Capital Markets.
"As of writing, the market continues to price in rate cuts for the rest of this year," she adds in a Tuesday market commentary.
While Tuesday's data was followed by a modest tick higher for Canadian Dollar exchange rates, its developments across the border in the U.S. and others in the banking segment of the stock markets that RBC strategists expect to drive GBP/CAD lower this week and thereafter.
Lignos and colleagues advocated previously on Monday that clients of RBC sell GBP/CAD around 1.6742 and look for a fall back toward 1.6150 unless and until the exchange rate rises above the 1.69 level.
"Tomorrow’s FX reaction is more likely to be driven by what happens further out the curve than whether or not the Fed delivers a 25bp hike for now," Lignos writes in Tuesday commentary.
"For now we are positioned with short GBP/CAD on an expectation that US 2y rates end the week higher in yield (CAD dragged up as mini-USD proxy) but that if we don’t and we see renewed bank turmoil, GBP starts to suffer as a bank stock proxy," she adds.
Calm had been restored and renewed risk appetite was evident in global markets on Tuesday where banking stocks led a recovery in broader stock indices across many jurisdictions, seemingly drawing a tentative line under weeks of heavy selling.
This followed speculation suggesting the U.S. Treasury is examining ways in which all deposits in the banking system could be temporarily guaranteed so as to discourage the herd-like 'bank run' behaviour that led to the failure of Silicon Valley Bank and other regional lenders earlier in March.
"The situation is stabilizing. And the U.S. banking system remains sound. The Fed facility and discount window lending are working as intended to provide liquidity to the banking system. Aggregate deposit outflows from regional banks have stabilized," U.S. Treasury Secretary Janet Yellen told the American Bankers Association's Washington DC Summit on Tuesday.
Tuesday's recovery for risk assets also followed hard on the heels of a government-brokered merger between two of Switzerland's largest banks at the weekend, which was a direct response to speculative selling of Credit Suisse shares in the wake of recent events in the U.S.
But in the absence of any renewed turbulence in the banking sector, it's this Wednesday's Federal Reserve interest rate decision and its possible effect on the U.S. Dollar that would be the motivator of RBC Capital Markets strategists' bearish view on the outlook for GBP/CAD.
"The Fed is tough to call - it is highly unusual 48hrs before the decision for markets to not be fully priced for an outcome (which the Fed then delivers in line with expectations). That they have not leaked to guide markets suggests the FOMC itself is still unsure," Lignos writes in a Monday trade briefing.
"Nevertheless, there are a lot of cuts priced for H2 and we doubt the Fed will feel comfortable ratifying those. U.S. 2Y yields are plumbing 6m lows today - we look for them to go higher post-FOMC and to drag CAD up on the crosses as a mini-USD proxy," she adds.