Canadian Dollar Advances after Shock Export Surge Bolsters Economy and Interest Rate Outlook

-CAD rises after sharp and surprise narrowing of trade deficit.

-Trade deficit falls to just -$626 mn in June, from -$2.7 bn in May.

-Bolsters Canadian growth outlook, raises odds of September rate hike. 

© Pavel Ignatov, Adobe Stock

The Canadian Dollar rose Friday after official data showed exports surging in June, bolstering expectations of the economy for the second quarter and raising the odds of another Bank of Canada interest rate rise before the year is out. 

Canada's trade deficit shrank to just -$626 million during June which, down from -$2.7 billion in May, is far ahead of the consensus for a balance of -$2.3 billion.

This came after exports surged by 4.1% to a record $50.7 bn, which Statistics Canada attributes to activity in the energy and aerospace industries, and as imports fell by 0.2% to $51.3 bn. 

"Canadian trade was a large and pleasant surprise in June, and a surge in exports for the month capped a solid quarter," says Avery Shenfeld, chief economist at Toronto-based CIBC Capital Markets. "The result looks to bump Q2 GDP tracking to above 3%, ahead of the Bank of Canada's last projection by a few ticks."

Shenfeld says this should prove a bullish development for the Canadian Dollar and a negative for the bond market as it means traders are likely to become more confident about the odds of another Bank of Canada interest rate rise coming in either September or October. 

Trade balance data measures the difference in value between a nation's imports and its exports. Currency markets care about it as the data provides insight into supply and demand of a currency in the "real economy", while also giving a steer on the likely pace of GDP growth at the start of the second quarter.

A narrowing trade deficit suggests either that exports and their associated demand for a currency are rising, or that imports and their associated supply of a currency on global markets are falling. Both are typically good for a currency while a steadily narrowing trade surplus, or a widening deficit, is a negative influence.

The size and trajectory of a trade surplus or deficit is important for economic growth because imports are a subtraction in the calculation of GDP, while exports represent a credit to the value of economic output. As a result, rising exports and, or, falling imports can help boost the economy.

The USD/CAD rate was quoted 0.21% lower at 1.2996 following the release after extending an earlier 0.045 loss, while the Pound-to-Canadian-Dollar rate swiflty converted a 0.02% gain into a 0.36% loss when it fell at 1.6888. The Canadian Dollar was higher against all other developed world currencies Friday.

"Bulls are hanging on to their USDCAD longs as long as recent lows stay in place but CAD is quite firm in the crosses as the BoC outlook has managed to keep pace with the Fed’s in recent weeks," says John Hardy, chief foreign exchange strategist at trading firm Saxo Bank. 

Friday's trade numbers come closely behind GDP data released last week, which showed Canadian economic growth rising by 0.5% during May, up from 0.1% previously.

This puts Canada's economy on track to achieve annualised growth of around 3% for the second quarter overall and has helped repair what was previously a downbeat outlook for Canadian interest rates. 

The Bank of Canada raised its interest rate for the fourth time in the last 12 months this July, taking it up to 1.5%, and signalled its intention to continue withdrawing stimulus from the Canadian economy over the coming quarters.

Changes in interest rates, or hints of them being in the cards, are only normally made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

Most measures of Canadian inflation are already at or above the BoC's 2% target while the Bank said in July that it expects this to remain the case out until at least 2020. Moreover, Friday's trade data means the odds of another BoC rate hike coming inside of 2018 may have just risen. 

Pricing in overnight index swaps markets, which enable investors to protect themselves against changes in rates but also provide insight into expectations for monetary policy, implied an October 24, 2018 cash rate of 1.68% on Friday. This suggests markets see a very high probability of another rate hike coming before then. 

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