This admonition is unsurprising given Macklem’s general reluctance to declare victory over inflation. While the Bank of Canada increasingly sees the elements needed to get inflation back down to 2%, Macklem stated that “we are not there yet.” They need to see sustained and further (for “a number of months”) downward momentum in core inflation.

Cautious About the Signs of Victory Over Inflation

December’s statement on monetary policy also reflected the Bank of Canada’s wavering. The statement estimated that “data and indicators for the fourth quarter suggest the economy is no longer in excess demand. The slowdown in the economy is reducing inflationary pressures in a broadening range of goods and services prices.” These conditions should have generated a declarative victory statement. Instead, the Bank of Canada proceeded to posture staunchly against inflation: “Governing Council is still concerned about risks to the outlook for inflation and remains prepared to raise the policy rate further if needed. Governing Council wants to see further and sustained easing in core inflation, and continues to focus on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”

Still, in the interview, Macklem acknowledged that rates are likely to start coming down in 2024. He just refused to provide a timetable.

The Soft Landing

The interviewer pointed out that the scenario Macklem portrays sounds like a “soft landing” for the economy. Macklem was careful not to use that term. Instead he pointed out that much of the adjustment in the labor market has come through a reduction in vacancies instead of a large rise in unemployment. An anticipated weakness in growth for the next 2 to 3 quarters should not generate a “deep” recession. Macklem directly claimed that “we can get inflation back to 2% without a recession.”

This year will be a transition year. By the end of the year, the economy should be in soft landing mode if all goes well.

The Canadian Dollar

The Bank of Canada released its December statement on monetary policy just as the U.S. dollar was experiencing a slight relief rally against the Canadian dollar (USD/CAD) (or the Invesco CurrencyShares Canadian Dollar Trust (FXC)). The slide resumed with the Federal Reserve’s decision on monetary policy the following week and the resulting celebration over the implicit announcement that inflation in the U.S. is dead. I had long anticipated the decline at the time with a target of testing the lower part of a trading range in place since September, 2022.

After taking profits, I am back to accumulating a short position. I expect the Bank of Canada’s on-going caution and the Bank’s refusal to get dovish to act as a tailwind for the Canadian dollar. The chart below from TradingView.com shows volatility in USD/CAD distinctly driven by key events. The Bank of Canada’s next Monetary Policy Report will come on January 24th. The Fed comes around the week after.

So, overall, I continue to favor playing the trading range in USD/CAD as an eventual trip to or toward the bottom of the range. I currently cannot foresee catalysts that will push the currency pair to stray too far away from the range. If USD/CAD escapes the range, I think the odds favor a breakdown over a breakout.

Be careful out there!

Full disclosure: short USD/CAD

The post Bank of Canada’s Macklem: The End is In Sight But Rates Are Not Returning to Pre-Pandemic Levels appeared first on Inflation Watch.

The Bank of Canada is worried about higher energy prices, “structural pressures” in the housing market primarily related to supply shortages (which it acknowledged must first be addressed on the supply side), and “persistence in underlying inflation.” This underlying inflation consists of elevated “near-term inflation expectations and wage growth” and corporate pricing decisions that are “normalizing only slowly.” Core inflation on a year-over-year basis has come down, but the 3-month view shows little downward momentum. Accordingly, the Bank of Canada put the country on notice that it is leaving the door open to future rate hikes because of the stubborn uncertainty in getting inflationary pressures down.

Yet, the BoC did not proceed with a rate hike. Counterbalances to the increased inflation risks remain. Overall supply and demand in the Canadian economy is almost in balance with the trend favoring excess supply. The BoC also downgraded its outlook for economic growth because the economy slowed more than expected back in July; less excess demand exists than expected.

So while the BoC hiked its expectation for inflation from 3% to 3.5% for next year, the central bank is sticking to its longer-run projection of 2% in 2025. Thus, Macklem felt confident in reassuring Canadians: “with clearer evidence that monetary policy is working, Governing Council’s collective judgment was that we could be patient and hold the policy rate at 5%.“ Interest rates will stay higher for longer and the inflation target remains in sight.

Corporate and Government Behavior Working Against Monetary Policy

Companies and Canadian governments in aggregate are not cooperating with the objectives of monetary policy.

Canadian companies are still passing along price increases to consumers faster than normal. From the Monetary Policy Report:

“Corporate pricing behaviour has yet to normalize. Businesses continue to increase prices more frequently and by a larger amount than normal… This may indicate that households and businesses are, respectively, expecting to pay more and charge more for goods and services. High inflation expectations could also feed into wages.”

I assume this dynamic also comes from lingering excess demand which makes consumers less price sensitive. The coming era of excess supply should work counter to this effect.

During the Q&A Macklem pointed out that the fiscal spending plans are working against monetary policy. Aggregate government plans will grow spending by 500 basis points greater than the potential growth of the Canadian economy. Thus, the economy will add more demand than supply. In the past year, growth in government spending was below 2%. Macklem indicated that it would be helpful if fiscal and monetary policy were “rowing together.” The BoC’s forecasts take into account the potential future inflationary pressure from government spending.

The Canadian Dollar Trade

The bump higher in hawkish rhetoric did not benefit the Canadian dollar, perhaps because the BoC maintained its longer-term expectation for inflation. Weakness in the currency Invesco CurrencyShares Canadian Dollar Trust (FXC) or strength in USD/CAD continued until the Federal Reserve’s last policy announcement. Financial markets painted a dovish interpretation to the accompanying news even though it read like nothing materially changed.

I did not expect the drift higher (with high volatility) in USD/CAD as I accumulated a short position. I continue to hold the position as I see two main factors working against my thesis reaching their own individual extremes.

The biggest shift against my original setup was a big increase in the spread on 10-year yields between U.S. and Canadian bonds. Just over a month ago this spread sat at a level that looked like a potential bottom. Shortly thereafter, the bottom dropped out. The spread was last this wide back in March, 2019. This large spread serves advantage to the U.S. dollar over the Canadian dollar. From World Government Bonds:

Oil has also worked against my original thesis. Oil did not stabilize. While it soon spiked higher in response to Hamas’s attack on Israel, selling in oil resumed in about 10 days. Last week, the United States Oil Fund, LP (USO) hit a 3+ month low. While this decline should reduce the Bank of Canada’s fear that higher energy prices will bleed their way into pressures on core inflation, it also works against the Canadian dollar as a commodity currency. I have dropped any expectation on oil although I am net short USO. From TradingView.com:

From a technical perspective, USD/CAD remains well-supported by its uptrending 50-day moving average (DMA) (the red line below). I still expect this uptrend to break to the downside as the extremes working against the Canadian dollar lose steam. To the upside on USD/CAD I have a clear stop loss point above the peak created by the reaction to the Federal Reserve’s November 1st announcement on monetary policy. From TradingView.com:

Be careful out there!

Full disclosure: short USD/CAD, net short USO (short shares, long call spread)

The post Canada’s Version of Higher for Longer: Inflation Risks Have Increased appeared first on Inflation Watch.

Back in April, the Bank of Canada (BoC) described a goldilocks narrative on inflation. This narrative featured the annual change in the Consumer Price Index inflation (CPI) gradually returning to the 2% target at the end of 2024 with economic growth picking up alongside inflation’s downward glide path in 2024. Just two months later in June, the Bank of Canada raised concerns about stubborn inflation and on-going high excessive demand. Accordingly, the BoC took its finger off the pause button on rate hikes and wrote an insurance policy on inflation with one more rate hike. The latest stall in inflation’s trend caused market expectations of a rate hike in October to surge from 23% to 42%.

The Canadian dollar surged along with rate hike expectations. The Canadian dollar was already rallying against the U.S. dollar (USD/CAD) going into the inflation print despite the U.S. dollar’s strength against other major currencies. The chart below shows how the Invesco CurrencyShares Canadian Dollar Trust (FXC) gapped higher at the open but faded from the intraday high. While the intraday action may represent an element of sell on the news, I think the path of least resistance is higher for the Canadian dollar until some new inflation data contradicts the revival of inflation concerns. I sold a small position short on USD/CAD to take advantage of the small fade.

I am not expecting the Federal Reserve’s coming announcement on monetary policy to change the trajectory. Accordingly, I will add to my position if USD/CAD rebounds further.

Drivers of Core Inflation

Core inflation was supported by accelerating rent prices. Ironically, Statistics Canada partially blamed high mortgage rates which are of course higher thanks to the BoC’s rate hikes to fight inflation:

“Shelter prices were up 6.0% on a year-over-year basis in August, after increasing 5.1% in July. Faster growth in shelter prices was led by the rent index, which rose 6.5% year over year nationally, after a 5.5% gain in July. Among other factors, a higher interest rate environment, which may create barriers to homeownership, put upward pressure on the index.”

Presumably, the higher mortgage rates are forcing more people than usual to choose renting over buying and in turn pressuring vacancy rates. Lower vacancy rates tend to push rent prices higher.

I might next need to write about a Canadian inflation conundrum!

Be careful out there!

Full disclosure: short USD/CAD

The post A Stall in Canada’s Core Inflation Narrative appeared first on Inflation Watch.

“While CPI inflation has come down largely as expected so far this year, the downward momentum has come more from lower energy prices, and less from easing underlying inflation. With the large price increases of last year out of the annual data, there will be less near-term downward momentum in CPI inflation. Moreover, with three-month rates of core inflation running around 3½-4% since last September, underlying price pressures appear to be more persistent than anticipated. This is reinforced by the Bank’s business surveys, which find businesses are still increasing their prices more frequently than normal.”

I have seen more and more references to base effects regarding U.S. inflation. In the previous two years, base effects could be used to dismiss inflation’s threat. This year, base effects from more challenging comparables are looming as the end of the tailwinds for disinflation (on a year-over-year basis). The timing is poor. As the Bank of Canada noted, underlying inflation has gone nowhere for almost a year. At this point, sticky inflationary pressures cloak more uncertainty around prior inflation expectations:

“In the July MPR projection, CPI inflation is forecast to hover around 3% for the next year before gradually declining to 2% in the middle of 2025. This is a slower return to target than was forecast in the January and April projections. Governing Council remains concerned that progress towards the 2% target could stall, jeopardizing the return to price stability.”

Surprisingly, markets took the news in stride. At the same time the U.S. stock market celebrated a pleasing report on U.S. June inflation, the Bank of Canada’s rate hike did not dampen spirits about the prospects for a more dovish Federal Reserve. Currency markets reacted as though the Fed might even be closer to rate cuts as losses in the US. dollar continued apace.

In fact, the market almost seemed to skip right over the Bank of Canada’s news. While majors like the euro and the British pound rallied all day against the U.S. dollar, the Canadian dollar enjoyed just brief intraday strength in the wake of the Bank of Canada’s decision to hike rates another 25 basis points. At the time of writing, USD/CAD is only just now returning to its low point following the rate hike (and looks stalled right at support).

On a daily basis, the Canadian dollar looks set to resume its momentum against the U.S. dollar IF USD/CAD breaks below yesterday’s low. Otherwise, a countertrend rebound could take USD/CAD right back to downtrending resistance at the 50-day moving average (DMA) (the red line below) as the next move.

I remain bearish on USD/CAD (bullish the Canadian dollar), and I expect rallies to continue to fail just as they have since September. The path downward on USD/CAD (upward for Invesco CurrencyShares Canadian Dollar Trust (FXC)) has been slow and choppy yet ever so slightly biased toward more relative strength for the Canadian dollar. The next major test comes with the Federal Reserve’s meeting later this month. More Fed hawkishness at that time could refresh the U.S. dollar against all majors for a spell.

Be careful out there!

Full disclosure: no positions

The post Base Effects Add to the Bank of Canada’s Inflation Concerns appeared first on Inflation Watch.

USD/CAD looks primed to break through support from the April and May (intraday) low. Source: TradingView.com

The decision to hike rates followed on the heels of a surprise interest rate hike from the Reserve Bank of Australia. The RBA warned that the country’s 7% inflation “is still too high and it will be some time yet before it is back in the target range.” The growing realization across the globe that inflation could remain stubbornly high runs counter to the narrative that the peak in inflation also means the imminent end of inflationary pressures. Central banks will have to keep fighting. The BoC referred to this global realization despite weakening macroeconomic conditions: “While economic growth around the world is softening in the face of higher interest rates, major central banks are signalling that interest rates may have to rise further to restore price stability.”

Still, economic conditions in Canada surprised the BoC to the upside. Q1 GDP growth came in at 3.1%. A tight labor market is combining with increases in spending on “interest-sensitive goods” to generate consumption that is “surprisingly strong and broad-based.” Under these conditions, the BoC has plenty of cover to get off the fence and hike again.

The Trade

The technicals are looking ever so slightly better for the Canadian dollar to deliver a major breakthrough against the U.S. dollar. I thought April’s break of support at the 200-day moving average (DMA) (the bluish line in the above chart) signaled the big breakthrough. Instead, USD/CAD proceeded from there to pivot around its 200DMA. However, the double peak in April and May firmed my preference to go long the Canadian dollar. Now the currency pair is challenging the support from the April and May lows which ended a subtle series of higher lows since August of last year. Perhaps most importantly, if and when the U.S. Federal Reserve finally gives in to the market’s expectations for rate cuts, I expect the Canadian dollar to be a prime beneficiary with the potentially bullish implications for commodities.

Be careful out there!

Full disclosure: short USD/CAD

The post Stubborn Inflation and Excess Demand Spook the Bank of Canada appeared first on Inflation Watch.