Analysis – Loonie Bulls swings as Bank of Canada lags behind Fed on final interest rate bets

Analysis – Loonie Bulls swings as Bank of Canada lags behind Fed on final interest rate bets


By Fergal Smith

TORONTO (Reuters) – With rising borrowing costs slowing in Canada’s massive housing market, investors are betting the Bank of Canada will raise interest rates to a lower end point than the Federal Reserve, an outcome that could spell more trouble for the Canadian dollar.

The Bank of Canada set the pace of tightening this year among the central banks that oversee the 10 most traded currencies, raising its key interest rate by 300 basis points to a 14-year high of 3.25% to tackle high inflation.

But in the face of growing Fed optimism and indications that higher borrowing costs may actually slow the Canadian economy, money markets are now betting that the Fed will end the tightening cycle with a higher rate policy from the Bank of Canada.

The US central bank last week raised its key overnight interest rate by three-quarters of a percentage point to the 3.00%-3.25% range and signaled more significant increases ahead.

Investors expect the Fed’s policy rate to reach a final rate of about 4.60% by the end of the first half of 2023, compared to about 4.10% for the Bank of Canada interest rate. Just a few weeks ago, the end point of both central banks was seen at around 3.75%.

It’s not uncommon for the Bank of Canada rate to fall below the Fed, but it threatens to pour cold water on the expectations of the Canadian dollar bulls that interest rate differentials will help support the currency over the next year.

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Data released by the US Commodity Futures Trading Commission on Friday showed that speculators cut net long positions in the Canadian dollar to the lowest level since early June.

“We’re getting to interest rate levels as markets look at the impact that will have on the Canadian economy, and see that the Bank of Canada will have a hard time matching the Fed in a tightening cycle,” said Andrew Kelvin, chief strategist for Canada. In TD Securities.

LOONIE slides

Canadian bond yields have fallen below their US counterparts in recent weeks, another possible sign that investors see higher interest rates as less sustainable in Canada.

The yield curve inversion, a potential harbinger of a recession, also grew deeper in the Canadian bond market than in the United States.

The Canadian dollar has fallen 7.5% against the dollar since the beginning of the year. That’s a better performance than the euro, yen and other G10 currencies, although almost all of that decline has occurred since mid-August.

The decline in the price of oil, one of Canada’s main exports, was additional headwinds to the United States, which on Monday touched its weakest intraday level since May 2020 at 1.3808 per US dollar, or 72.42 US cents.

โ€œInvestors are watching negative (Canadian) employment gains, slowing consumption growth, and evidence of a slow-moving train wreck in the housing market,โ€ said Carl Chamota, chief market strategist at Corbay in Toronto.

“With interest rates going up in the US and at home, the (economic) burden is increasing day by day.”

The Canadian housing market has slowed rapidly in recent months, while its share of the economy, at 9%, is nearly double that of the US housing market.

Additionally, Canadians are more likely to face mortgage renewals sooner than Americans – the most common mortgage term in Canada is five years, compared to 30 years in the US – and Canadian household indebtedness is highest in the G7, a group that includes the US Germany, Japan, Britain, France and Italy.

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โ€œThe Canadian economy is more rate sensitive than the US economy,โ€ said Royce Mendes, managing director and head of macro strategy at Desjardins.

โ€œEvery rate increase in Canada will come out faster and more pronounced than an equal dose of monetary tightening in the United States would.โ€

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