Inflation and retail sales to drive CAD

18 December, 2019

It’s a busy week in Canada, where CPI inflation data will hit the markets on Wednesday, ahead of retail sales on Friday. The loonie soared lately, as the de-escalation in trade tensions and the gains in oil prices painted a sunnier picture for the export-heavy Canadian economy, prompting investors to price out expectations of Bank of Canada (BoC) rate cuts. The subdued pricing implies that any disappointments in economic data going forward could come as a major ‘reality check’ for markets.

Catching a cold?

The Canadian economy remains solid overall, though some disappointing employment data last week brought this cheerful narrative into doubt. The unemployment rate unexpectedly jumped to 5.9%, from 5.5% previously, raising the question of whether this was just a ‘blip’ in an otherwise healthy jobs trend or whether the labour market is starting to show real signs of weakness.

Yet, investors are confident this won’t push the BoC to cut rates anytime soon. Most other economic indicators remain healthy, with inflation being in line with its target, real wages growing at a healthy clip, and the housing market picking up again.

Perhaps more importantly, the US and China reached a phase one deal last week, and while it was thin on substance, it was still enough to materially reduce the risk of any further escalation. The good news also pushed energy prices higher, providing another pillar of support for the loonie, as crude oil is Canada’s biggest export.

BoC on hold – asymmetric risks

All this has traders thinking that the BoC won’t cut rates moving forward. Market pricing currently assigns only a one-in-three chance for a rate cut over the entire next year, which is fairly low considering how many things can ‘go wrong’ in a period of twelve months.

The subdued pricing implies that the risks surrounding the loonie from economic data are asymmetric. If the data remain solid, that would merely reaffirm that the BoC will stay on hold for the foreseeable future, and therefore push the loonie higher – but only modestly. There’s not much left to price out in terms of rate cuts. On the flipside, any data weakness or a reescalation in the trade war could see pricing for BoC rate cuts soar rapidly, and by extension trigger much bigger losses in the loonie.

Steady as she goes?

The upcoming figures are expected to confirm that the economy remains in a good place. On an annual basis, inflation is forecast to have accelerated to 2.2% in November, from 1.9% earlier. Core inflation measures – the trimmed mean CPI and the median CPI – will also be in focus. Meanwhile, retail sales are projected to have risen by 0.5% in October on a monthly basis, a rebound following a 0.1% decline in September.

As per above, if the actual figures meet or exceed the forecasts, the loonie might gain but any upside would likely be smaller in magnitude compared to the losses in case these data disappoint.

Looking at dollar/loonie technically, initial resistance to advances may come at the 1.3200 handle, where the 200-day simple moving average (SMA) is located as well.

On the downside, the first obstacle for the bears may be the 1.3110 zone, with a downside break opening the way for a test of the 1.3040 region.

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