Canadian Dollar Primed for "Buy the Rumour, Sell the Fact" Response to BoC Rate Hike say Analysts

-Bank of Canada to raise rates but eschew forward guidance.

-Analysts see "Buy the rumour, Sell the fact" response from CAD.

-USD/CAD eyes 1.35 but better to sell CAD/SEK, CAD/NOK say CIBC.

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The Canadian Dollar rose against a majority of its developed world rivals Tuesday but analysts are increasingly of the view that gains for the currency will be short-lived, as Wednesday's Bank of Canada (BoC) meeting is likely to produce a classic "buy the rumour and sell the fact" reaction from the market.

Bank of Canada Governor Stephen Poloz is widely expected to announce a fourth Canadian interest rate rise inside of 12 months on Wednesday, taking the Canadian cash rate up to 1.5%, but it will be the BoC's commentary on the economy and the so called "trade war" that garners most of the market's attention. 

"The BoC looks set to hike this week but we think this falls into a "buy the rumor, sell the fact" trade for the loonie. We continue to like buying into USDCAD dips towards 1.30, especially as it starts to screen cheap on High-Frequency-Fair-Value [estimates]. We also like fading AUDNZD rallies towards 1.10," says Mark McCormick, North American head of FX strategy at Toronto-based TD Securities.

Pricing in overnight index swaps markets implies a July 11 cash rate of 1.48%, which suggests an almost 100% probability of a rate hike on Wednesday. As a result, much of the good news for the Loonie is already in the price and so there is little for the currency to gain from a solitary rate rise. 

This would normally mean "forward guidance" on future monetary policy would dictate where the Canadian Dollar finishes up after the announcement but a speech given by Poloz last week made clear the Bank will not be giving any such guidance this time around, or at any other meeting in the new future. 

Reasons given by Poloz for abandoning forward guidance were numerous, although they do little to quash suspicions that after Wednesday's rate rise, the BoC will face an extended period of time "on hold" before it is able to raise rates again. That's if it even does raise rates again in this cycle. 

"The growth story peaked last year, and our confidence is low that the other sectors of the economy are strong enough to weather the pullback in consumption. A few segments have room to grow but are unlikely to accelerate enough to offset the slowdown in domestic demand, suggesting the policy rate won't hit the 2% mark until next year. Trade disputes and the NAFTA saga only intensify downside risks," McCormick adds. 

The Loonie and Bank of Canada are caught between a rock and a hard place. On the one hand, Canada's economy has shown signs of recovering from a first-quarter lull but growth is still expected to remain below the elevated pace seen in 2017. On the other hand, President Trump's "trade war" remains a particular threat to the Loonie and Canadian economy. 

Officials from both sides of the border have been attempting, without success, to renegotiate the North American Free Trade Agreement for nearly a year now. 

TD Securities previously estimated that a US withdrawal from NAFTA could see the Canadian Dollar fall by 20%, while the BoC has also frequently flagged the trade saga as a significant risk to its own outlook for the economy. 

Talks are now seen dragging on through the rest of 2018, which is negative for the Loonie, so long as the White House avoids the nuclear option of simply announcing a US withdrawal from the pact.

"Governor Poloz recently spoke and gave a clear indication that the BoC was still leaning toward a rate hike at this meeting," says Derek Halpenny, European head of global markets research at MUFG. "Given the global backdrop, and given the decision is still quite finely balanced, there is certainly a good chance the communication on Wednesday indicates a high level of caution going forward. That suggests to us that while [it] will help support CAD, the prospect of any notable strengthening is limited with this hike now well priced." 

Halpenny and the MUFG team say the BoC is still likely to raise rates this week but that NAFTA uncertainty will mean Poloz adopts a cautious tone when it comes to the Canadian economic outlook. 

"The evolution of risks in the Monetary Policy Review will say a lot about the directionality of the CAD in the months and quarters ahead," says Bipan Rai, a macro strategist at Toronto-based CIBC Capital Markets. "To us, the most pertinent risks are those related to trade, the tightening in global financial conditions and domestic issues including household debt and consumption."

Rai and the CIBC team say there is a chance the USD/CAD rate will rise above the 1.35 level during the coming weeks but they prefer exploiting weakness in the Canadian Dollar by betting on a fall in its value relative to the Swedish Krona, whi has recently drawn support from a pending monetary policy shift at the Swedish central bank, as well as the Norwegian Krone which has benefitted greatly from the 16% rise in European oil prices during 2018. 

The USD/CAD rate was quoted 0.14% higher at 1.3130 during the noon session Tuesday while the Pound-to-Canadian-Dollar rate was 0.33% higher at 1.7434. Both exchange rate performances represent losses for the Canadian currency, although the Loonie was quoted higher against all other developed world currencies on the day. 

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