May 21 2024: The Canadian dollar has struggled compared to other pro-cyclical currencies since early May, largely due to its correlation with U.S. economic data and expectations surrounding Federal Reserve rate decisions. Analysts have been anticipating a 25 basis point rate cut by the Bank of Canada (BoC) in June, a forecast that has persisted for several months. This expected policy move is likely to reduce the Canadian dollar’s attractiveness relative to other commodity-linked currencies.
Factors Influencing Rate Cut Expectations
The primary justification for the anticipated rate cut has been inflation’s proximity to the BoC’s target range. However, a significant increase in job creation in Canada during April has introduced uncertainty into this dovish outlook. Today’s release of April’s Consumer Price Index (CPI) data is pivotal, as it could influence market expectations regarding the BoC’s June interest rate decision. Analysts are particularly focused on whether the core CPI “trim” measure will match the BoC’s other preferred core inflation indicator, the “median,” and fall below 3%. If both core and headline inflation metrics fall within the 1-3% target range, it may complicate the BoC’s case for maintaining a restrictive monetary policy.
Market Sentiment and Currency Movements
Currently, the market appears to be underestimating the likelihood of a rate cut in June, with only an 11 basis point adjustment priced in. There is also speculation that the Canadian dollar could weaken further as the potential rate cut becomes more anticipated by the market, leading to increased dovish positions on the Canadian interest rate curve. If inflation declines as expected in today’s data, the USD/CAD pair could approach the 1.3700 level in the near term. Additionally, currency pairs such as CAD/NOK and NZD/CAD might more clearly reflect the policy divergence.
Impact of Upcoming Economic Data
Today’s CPI data release is critical. Should inflation metrics, particularly the core CPI “trim” and “median,” align within the BoC’s target range, it may strengthen the argument for a rate cut in June. Conversely, if inflation remains high, it could challenge the dovish outlook and impact the Canadian dollar’s performance.
In summary, the Canadian dollar remains under pressure amid expectations of a rate cut by the BoC, with today’s CPI data playing a crucial role in shaping future market movements. The market’s current underestimation of the rate cut possibility could lead to further currency depreciation if dovish expectations are confirmed.
