BoC: Markets expecting rate hike today – Deutsche Bank

Alan Ruskin, Macro Strategist at Deutsche Bank, lists down the scenarios for the outcome of today’s BoC meet and points out that markets are almost universally inclined towards the rate hike.

Key Quotes

“Four scenarios are considered.  i) The BoC does not hike - USD/CAD heads to 1.32; ii) a dovish hike: the BOC hikes but undermines strong expectations of another hike this year – a sustained ‘buy the rumor sell the fact’ response with USD/CAD to 1.30+; iii) an as expected hike: the BOC hikes, and validates the rates curve built around the removal of 2015 emergency easing.  A ‘buy the rumor sell the fact’ response that gives way to a softer USD/CAD back below 1.29; and, iv) the BOC hikes, and affirms hikes are part of a bigger ‘normalization’ rate cycle - USD/CAD starts an eventual move to 1.25.    Given the scenarios above, the 1 day USD/CAD implied vol pricing of ~20 vols on the day if anything looks too low.”

“By far the easiest way for the Bank of Canada to explain a hike in the current context is to concentrate on a tightening being a removal of past emergency easing that is no longer warranted.  The one issue, here is that the Bank of Canada eased twice in 2015 to negate risks related to weaker oil prices, so that the removal of emergency easing would surely warrant two 25bp rate hikes, and possibly more.   The interesting aspect is that the rates market looks very reasonably priced for a rate hike explained as the removal of past emergency tightening.  The market has 86% probability of a rate hike today.  In addition, the October meeting has 41.5bps of cumulative (including July) tightening priced in, meaning that if the BOC hikes, the market has already priced in a 66% probability of another hike by October.   If the BOC does hike in July, one would presume this 66% will extend slightly, but to no more than an 80% probability.”  

“So what are the wider lessons that are likely to be learned from the BOC?  

If they hike as the market expects, it will be consistent with a view that Central Banks are serious about reeling back extreme emergency easing measures, and are prepared to do so even when it conflicts with their formal inflation targets.   In the unlikely event the BOC starts to talk more about rate normalization, this will be seen as a suggestive of a more extensive rate hiking cycle, although this may be less applicable to other Central Banks notably the BOE and ECB.    While every Central bank has a different approach, the fact that the BOC has been able to switch their approach so swiftly, is a warning that Central banks are in a rare moment, where some core assumptions are being questioned and they are more open to change, with this flexibility a factor adding to rates vol and vol attached to Central banker speeches. 

Lastly, the Bank of Canada like other Central Banks will be tracking financial conditions carefully in the hope that small short-end rate adjustments do not lead to excessive financial conditions tightening.  The BOC will be keen to avoid scenario iv) above, where the CAD starts appreciating sharply, and the causation from rates to FX will start to swing around, as much additional CAD appreciation, will quickly slow the BOC tightening path.”