Don't Fight Canadian Dollar Weakness: Bank of America

Image © Bank of Canada

Don't fight Canadian Dollar weakness against the Dollar in the wake of the Bank of Canada's (BoC) latest interest rate decision and guidance, say strategists at a leading Wall Street bank.

Bank of America says they interpreted the BoC's October 25 statement as keeping alive the potential for further rate hikes, which can support the Canadian Dollar in the medium term, but this support would only likely be afforded to non-USD pairs.

This suggests a nuanced performance from the Canadian Dollar ahead, where weakness against the Dollar is possible, but strength against European currencies such as the Euro and Pound is possible.

Although the BoC opted to keep interest rates unchanged on October 25, it remains data-dependent and has not written off further hikes owing to elevated domestic inflation risks, elevated oil prices and a still-tight labour market, according to Bank of America's analysis.

As such, "investors are likely better off expressing any short-term bullish CAD views on the crosses than vs the USD," says Howard Du, G10 FX Strategist at Bank of America.

The Canadian Dollar was softer against the majority of its peers after investors lowered the odds of another interest rate hike from the BoC following the release of new inflation and economic growth forecasts on October 25.

The BoC lowered its growth projections while also raising its inflation profile, creating something of a stagflationary mix that is scarcely ever supportive of a currency.

Furthermore, the central bank was keen to emphasise supply now exceeded demand in the economy, ensuring inflation was destined to fall back to target, albeit at a slower-than-previously-expected pace.

But Bank of America also sees evidence that suggests another rate hike cannot be discounted, meaning the market might have been too hasty in lowering expectations for such a move.

Above: CAD performance in the wake of the October 25 policy decision and guidance. Set up a daily rate alert email to track your exchange rate OR set an alert for when your ideal exchange rate is triggered ➡ find out more.

Evidence includes the central bank's desire "to see downward momentum in core inflation", as the Governing Council "is concerned that progress towards price stability is slow and inflationary risks have increased".

The BoC underlines that the labour market remains tight and wage growth remains a concern.

"We continue to expect the BoC to remain on hold for many months and to start its cutting cycle in June 2024," says Carlos Capistran, Canada and Mexico Economist at Bank of America Securities.

From a strategy perspective, Bank of America says, "don't fight the USD/CAD rally for now."

"While we are constructive CAD for the medium-term, investors are likely better off expressing any short-term bullish CAD views on the crosses than vs the USD," says Du.

Bank of America still sees reasons for the USD to rally in the near term as the U.S. economy is likely to retain its outperformer status at the same time global geopolitical risks are elevated.

"On the crosses, we are more bullish CAD vs EUR on oil supply factor-driven terms of trades divergence," says Du.