Image generated by OpenAI’s Dall-E model.

By Michael O’Neill

“Done Like Dinner!” That’s the prevailing sentiment among economists and analysts following the Federal Reserve’s 11th consecutive rate hike, which brought the overnight rate to 5.50%. They believe  the rate hike cycle that began in March 2022 has reached its peak. Chicago Mercantile Exchange (CME) futures traders agree, pricing in the first rate cut for March 20, 2024, with rates settling around 4.25% by the year’s end.

Fed Chair Jerome Powell doesn’t share the traders’ enthusiasm. He warned that the Committee “would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals.” That’s “hike rates if needed,” in Fed-speak.

At first glance, Mr. Powell’s comments sound a tad hawkish, suggesting a forceful response if inflation doesn’t continue to slide toward its target. But in a classic “CYA” maneuver, he deflected blame for further rate hikes by declaring “the FOMC will continue to take a data-dependent approach in determining the extent of additional policy firming that may be appropriate.”

Meanwhile, the European Central Bank (ECB) raised its benchmark rates by 25 bps to 4.25% on July 27. The ECB Governing Council believes that although inflation is declining, it will remain above the 2.0% target for an extended period. They are also concerned that the Eurozone’s near-term economic outlook has deteriorated due to weaker domestic demand, high inflation, and tighter financing conditions. What did they expect after raising rates 425 bps in just twelve months?

Like the Fed, the ECB is determined to drive inflation to its target by keeping interest rates at sufficiently restrictive levels, by using a data-dependent approach

President Christine Lagarde did not commit to another rate increase in September and instead offered a . “wishy-washy” prediction. She said “Do we have more ground to cover? At this point in time, I wouldn’t say so. “There is the possibility of a hike. There is the possibility of a pause. It’s decisive maybe.”

The Bank of Canada differs a little from the ECB and the Fed in that they are a “Data-Surprised” central bank. Their monetary policy communications are peppered with references about being “surprised.” They have expressed surprise about the strength of the economy, inflation resilience, and robust employment. They should add “surprised about keeping their jobs,” but that’s another issue.

Canadians shouldn’t be surprised if the BoC delivers another rate hike. JPMorgan Chase economists think another 25 bp rate bump will occur in October, then that’s it.

Despite central bankers’ optimism, they appear to have a more hawkish outlook for interest rates compared to the market. This expectation of higher interest rates could lead to increased volatility, especially during thin August markets. Traders are eagerly awaiting upcoming data, such as US and Canadian employment reports on August 4, US inflation data on August 10, and the Kansas City Fed’s Jackson Hole Symposium on August 24-26.

Amidst this uncertain environment, the outlook for the Canadian dollar remains murky, heavily influenced by broad US dollar sentiment. However, some domestic and international factors may help mitigate losses or gains.

For instance, West Texas Intermediate (WTI) has surged over 12.5% since July’s start, with potential for further gains. China has announced a series of targeted fiscal stimulus measures that traders hope will increase demand locally, while aggressive oil production cuts reduce supply. Russia cut production by 500,000 barrels per day in August, which will remain in effect until the end of 2024. Saudi Arabia voluntarily cut production by 1 million b/day and is expected to extend the cuts until October

Rising oil prices have an inflationary impact. While the BoC excludes energy from its core inflation calculation, the effects of higher oil prices permeate other categories through increased transportation costs among others.

USDCAD is directly impacted by Canadian and US interest rate differentials. Those differentials have narrowed in Canada’s favor since the beginning of July, which is helping to slow USDCAD gains in a bullish environment.

USDCAD has chopped in a 1.3080-1.3500 range, and the mid-point of that band is 1.3290. When prices are below the mid-point, the focus is 1.3080, and when above, the target is 1.3500. However, things get really interesting if the 1.2980 level gives way as it snaps the long-term uptrend line and shifts the focus to 1.2500.

And like any forecast and prediction, the technical outlook is data-dependent.