By Michael O’Neill

On December 5, the Bank of Canada (BoC) high-stepped to the tune of “Canadian rates are marching nowhere” as it left its benchmark overnight rate unchanged at 1.75%. That was widely expected. What wasn’t expected was the dovish policy statement, which contrasted sharply with what they said on October 24.

You will recall that in October, the BoC described the global economic outlook as solid and noted that the US economy was especially robust.  They sounded relieved about the US Mexico Canada Agreement (USMCA) on trade and suggested it would reduce investment uncertainty.They raised interest rates by 0.25% at that meeting, despite noting risks from the China/US trade conflict, and rising financial market volatility.

A mere forty-three days later, they pulled a U-turn. They said the moderation in global expansion was expected but then tacitly admitted they got the US/China trade dispute wrong.They said: “Recent encouraging developments at the G-20 meetings are a reminder that there are upside as well as downside risks around trade policy.”  They are the central bank of Canada, and they shouldn’t need a reminder about downside risks to trade policy.  

They patted themselves on the back for predicting third-quarter growth but then acknowledged momentum was slowing.  hey pointed out oil prices were sharply lower than they were at the October 24 meeting but seemed to “gloss” over the negative impact of falling prices on Canada GDP. 

Western Canada Select, (WCS) Alberta’s benchmark crude export is trading at a Canadian dollar discount of $31.83/barrel from West Texas Intermediate, (WTI) the North American benchmark. The discount would have been worse if Alberta didn’t curtail production by 325,000 barrels/day.

The BoC based its economic forecasts in the October Monetary Policy report using oil prices of $70/barrel for WTI and $35.00/b for WCS.  WCS is over $5.00/b below the October forecast. That discount could get worse if Saudi Arabia is unable to coerce other Opec members and Russia to agree to added production cuts.  Even then, the cuts may not be enough.  Iran said it wouldn’t consider any production adjustments while it was under sanctions and Qatar is quitting the cartel in January. Arguably, the BoC may have understated the risks to the domestic economy from weak oil prices. 

Oil prices are under threat from concerns about a global economic slowdown due to the ongoing US/China trade war.  President Trump and President Jinping left their Argentina dinner with what appears to be different conclusions. The American president is notorious for citing facts that he seems to pull from an alternative universe.  His tweet that China was cutting tariffs on US cars hasn’t been confirmed or acknowledged by China.  Trump appointed Robert Lighthizer as the chief trade negotiator for the Americans.  Some analysts believe the move signals the US will take a hard line in the talks.  Fears of failure or protracted negotiations will likely continue to weigh on global growth.

The Canadian dollar was hammered following the release of the BoC statement.  Traders were caught off-guard by the dovish tone.  The tone forced some economists to trim their rate hike forecasts for 2019, from four increases, to as low as two.  The statement downgraded January rate hike expectations as well.

Regardless of the latest reaction, the outlook for the Canadian dollar is fluid.  The BoC may be an important factor in price direction, but it is not everything.  The currency is also influenced by broad US dollar movements against the G-10 major currencies, and the Fed is a major influence of those moves.  

The US dollar has been on a roller-coaster ride for the past month.  Federal Reserve Chairman Jerome Powell was believed to have taken a dovish turn last week when he described US interest rates as “just below” the subjective “neutral level.” Two months earlier, he described those same rates as an “a long way from neutral.  That sparked a bond market sell-off, a stock market rally and a sharply weaker US dollar.  Since then, renewed China/US trade concerns, and falling oil prices triggered a shift to “safe-haven” assets and the greenback recouped its losses.   The Canadian dollar wasn’t considered a safe-haven, and it sank. 

Ongoing European Union issues and the UK Brexit debate add to market fickleness.  Another consideration for outsized FX moves is poor liquidity.  The latest round of volatility occurred during the run-up to the American Thanksgiving holidays.  The National Day of Mourning for the late George H. W. Bush on December 5 created another void.

If you believe in Santa Claus, it is safe to take the latest FX moves and the BoC statement at face value.  If not, you should regard them with a jaundiced eye.  On December 6, BoC Governor Stephen Poloz addresses CFA Society Toronto, at 5:50 am PST.  His speech is titled “Economic Progress Report and financial stability.” A press conference follows.   Traders will try to discover if the BoC has shifted policy or merely miscommunicated it.  Mr Poloz is the bandmaster and markets will march to the beat of his drum.