CAD rallies on bullish Poloz but should market trust the BOC head

Although we had three central bank meetings in Europe today, the biggest move in the FX markets was triggered by a speech from the Bank of Canada’s Governor this afternoon which sent the Canadian dollar surging higher. Stephen Poloz tried his best to talk up the prospects of economic growth in Canada, saying the economy “has made tremendous progress over the past year, and it is close to reaching its full potential.” He added that the BoC is “growing increasingly confident that the economy will need less monetary stimulus over time,” although it will continue to be cautious on interest rate hikes, in part because the labour market slack poses downside risks to inflation forecast. Still, he argued that the BoC sees potential early signs of firms offering higher wages, which should boost inflation.

Should the market trust Poloz?

But is Mr Poloz correct in being so bullish on the economy?  Yesterday I wrote a bearish piece on the Canadian dollar, as I talked about the prospects of a rally in the AUD/CAD. I argued that the CAD could head lower because of the fact the Bank of Canada has recently turned more neutral after being hawkish for a few months during the summer, and also due to crude oil, which is being sold in Canada at a significant discount of about $26.50 compared to WTI. Canada has its oil production concentrated in Alberta and there are no pipelines to ship the oil to the cost. Consequently, nearly all its crude is piped to its only customer – the US – where it is refined into various oil products. But thanks to the shale oil revolution, the US is fast becoming self-sufficient in its energy needs. So it relies increasingly less on crude imports. As a result, a huge glut has been built up in Canada. This could prove very costly for the Canadian economy and therefore its currency.

CAD/JPY could still turn lower

While the Canadian dollar did weaken yesterday and fell further earlier today, it has now turned sharply higher thanks to those remarks from Poloz. But I still don’t think Poloz being hawkish is a game changer. Canadian CPI and GDP will be among a handful of key macro-economic events worth keeping an eye on next week. If these figures do not confirm the BoC’s views then there is a risk we could see the CAD take a tumble, especially if crude oil continues to be sold at a heavy discount in Canada.

Meanwhile after four central bank meetings this week, the Bank of Japan is the last of the major banks to make a decision on monetary policy before the year is out. However, like most central banks that met this week, the BoJ is widely expected to keep its policy unchanged and unless it offers any fresh insights, the Japanese yen is unlikely to weaken significantly further as most of the dovishness is surely priced in. Consequently the Japanese yen could actually rise.

If this is the case, the CAD/JPY could come under pressure again – especially if Canada’s CPI and/or GDP also miss expectations. Ahead of next week’s macro events, the CAD/JPY has turned green, but remains inside a widening channel of lower lows and lower highs, which is bearish from a technical standpoint. Unless it breaks above the bearish trend line in the coming days, we will remain sceptical on the prospects of a speedy recovery in CAD/JPY.

Source: eSignal and FOREX.com