Canada FX Will Underperform the US

The Bank of Canada (the "BoC") hiked the policy rate by 50bps to 3.75% at its October meeting, a smaller move than markets had expected. The BoC noted several reasons to slow the pace: headline inflation was lower than forecast, business price expectations are falling, and long-term inflation expectations remained anchored (Charts 1 and 2). At the next meeting in December, the BoC may hike by 25bps or 50bps*, but they have been clear that future hikes will be limited as previous ones have yet to fully impact the economy.

One reason for the BoC's caution around further hikes is household leverage. Canadians have much higher debt burdens than Americans (Chart 2). Therefore, as higher policy rates transmit to higher mortgage payments, Canadians will probably reduce spending more aggressively. The difference in household leverage suggests the Federal Reserve (the "Fed") will hike rates higher than the BoC will.

*This article was written prior to the announcement of the 50bps rate hike by the BoC on December 7th.

READ ARTICLE

Related Articles

  • March 10, 2023
    Monetary tightening at the Bank of Canada (BoC) began in earnest in the first quarter of 2022, just a year ago. As all market participants know, the emergence of inflation, followed by a rapid response to raise the target rate from 0.25% in January 2022 to 4.5% by the end of January 2023 has caused a rise in 3-month CDOR (Canadian Dollar Offered Rate), from 0.5% to just over 5%; a painful move for anyone that was long on Three-Month Canadian Bankers' Acceptance Futures (BAX™) contracts during this time. At present, Montréal Exchange’s BAX contracts indicate that market expectations are that rate hikes will pause soon, followed by a more accommodative monetary policy within 12 to 15 months. For the moment, investors who disagree with these implied rates or with their path can execute trades in both BAX contracts and Three-Month CORRA Futures (CRA™) contracts.
    June 2, 2023
    In this article, we discuss several use cases for the 30-Year Government of Canada Bond Futures (LGBTM) in Canada.
  • June 1, 2023
    MX recently hosted a panel discussion of industry professionals about Canadian macroeconomic trends and their impact on the government bond futures market. This article summarizes the key themes from that discussion.
    May 31, 2023
    Canadian equities have performed well so far in 2023. The S&P/TSX 60 Index Futures traded on the Montréal Exchange has risen over 6% this year. Notably, this rally has occurred alongside falling volatility. The three-month (realised) volatility of the S&P/TSX 60 Index Futures has fallen from 17% at the start of the year to 11% at the start of May. This is the lowest since 2021 and lower than the current volatility in the US S&P 500(R) Index.