Canadian Dollar Downside Bias Heading into Midweek Rate Cut

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Currency strategists at Bank of America say they prefer to be 'short' the Canadian Dollar heading into the Bank of Canada decision.

"Maintain bearish CAD bias into the June BoC," says Howard Du, a G10 FX Strategist at Bank of America.

The call comes ahead of speculation the Bank of Canada might cut interest rates midweek. Markets are currently roughly split 50/50 on whether the Bank will move now or choose to wait until July.

Because the market is not fully priced for either outcome, there should be a degree of CAD volatility following the decision. The rule of thumb is that a cut will result in CAD weakness, while a hike can prompt a recovery of the currency's recent underperformance.

"We expect the BoC to cut its policy rates target at its June 5 meeting, as the economy remains weak, and inflation has fallen further since the April meeting. We expect forward guidance to remain data dependent," says Carlos Capistran, Canada and Mexico Economist at Bank of America.

The list of reasons to cut now is compelling, notes the economist:

  1. The economy has been growing below potential for four quarters in a row
  2. The output gap has closed
  3. Unemployment is above 6% and has increased more than 100bp since its trough
  4. Wage growth is at BoC's desired range
  5. Core inflation has been on a downward trend since January and is currently below 3.0%

As important as the decision itself will be, the Bank of Canada's guidance regarding the next steps is also crucial. If the central bank pushes back against expectations for subsequent rate cuts, CAD could ultimately recover any post-decision losses.

But a soft guidance that allows the market to expect further cuts can weigh.

"After June, we expect the BoC to cut the overnight rate at every meeting this year, to leave it at 3.75% by year-end," says Capistran. A steady stream of rate cuts from the central bank could weigh on CAD.

"The forward guidance would likely still be dovish enough to prevent the CAD from having any sustainable short-term rallies," says Du.

"Over the medium-term, we continue to hold a bearish CAD view against most G10 currency peers as the BoC proceeds with rate cuts while growth recovers for Canada," he adds.