The Bank of Canada (BoC) not only ended its quantitative easing (QE) program, but also the Bank refreshingly acknowledged the inflation issue in Canada. In his opening statement, Governor Tiff Macklem pointed out that higher energy prices and supply chain constraints are worse than previously assumed and are driving hotter inflation levels. Canadian inflation will be “higher for longer” relative to the July forecast.
Canadian Inflation
The end of QE follows a substantial reduction 6 months ago. It also signals a monetary campaign to make sure that inflation returns to the 2% target by the new projection at the end of 2022. Governor Macklem took every opportunity during the press conference to express his confidence in the Bank of Canada’s ability to guide inflation to target. He insisted that the Bank will “use its tools” to fight any unexpected inflation pressures.
The announcement’s immediate net impact on the Canadian dollar (FXC) was surprisingly minimal. USD/CAD swung through a wide range before settling right in the middle of the consolidation dominating trading since last week. At the time of writing, USD/CAD is even trading back to the top of the recent range.
The BoC expects Canadian inflation to rise from 4½ percent to 5 percent by the end of 2021. Macklem in turn acknowledged that “higher prices are challenging for Canadians, making it harder for them to cover their bills.” Accordingly, he reassured Canadians that “medium- to longer-term inflation expectations remain well anchored on the 2 percent target, and overall wage pressures remain moderate.” Moreover, the BoC remains “committed to ensuring that price increases don’t become ongoing inflation.”
Even as the BoC fights inflationary pressures in Canada, monetary policy overall remains highly accommodative. The BoC “held its target for the overnight rate at the effective lower bound of ¼ percent, with the Bank Rate at ½ percent and the deposit rate at ¼ percent.” Rates will stay at rock bottom levels until Q2 or Q3 of 2022 when the BoC anticipates that the economy will finally absorb all its slack. In what it calls the “reinvestment phase”, the Bank of Canada will replace maturing bonds. In other words, the end of QE is simply the end of growth in the Bank’s holdings of bonds.
The Job Market
Canada suffers from the same surprising combination of high unemployment and high job vacancies found in the U.S. Governor Macklem explained that it is possible companies do not have the capacity to hire all at once everyone they need. At the same time, many workers have moved on to other industries. From the opening statement:
“Our recent Business Outlook Survey indicates that labour shortages have intensified in two areas. The first is shortages of skilled trades and digital workers. This is a challenge that existed before the pandemic as well. The second is more pandemic-specific. As service businesses like restaurants and stores reopened this summer, many had trouble hiring workers quickly enough to meet the surge in demand. Part of this reflects the reality that it simply takes time for companies to find workers with the right skills, and for workers to find the right jobs. Repeated closures in some sectors and the challenges of working in high-contact jobs during a pandemic may also be affecting the workforce. About half of the unemployed workers who responded to the recent Canadian Survey of Consumer Expectations said they’re considering a move to a different industry.”
The stubborn disconnect in the labor market helped to compel the Bank of Canada to nudge GDP growth expectations downward to 5% in 2021. The July Monetary Report forecast 6% GDP growth for 2021. The rest of the GDP growth forecast remains the same: about 4 ½ percent in 2022 and 3 ¼ percent in 2023.
The Trade
I returned to shorting USD/CAD given the technical trends. Earlier, I flipped long as part of a larger expectation of a stronger dollar beyond the pressure on the euro. The chart above shows USD/CAD last peaked from July through September in three large swings. After each one, I thought USD/CAD would resume an upward push. The break below the 200-day moving average (DMA) (the blue line above) was the final signal that the technicals favored a return to downward pressure on USD/CAD. As a result, I used the Bank of Canada’s latest announcement on monetary policy to open a fresh short on USD/CAD. The currency pair is a short as long as it trades below the 200DMA. I assume the cut in the 2021 growth forecast will act as a short-term headwind against the Canadian dollar.
Be careful out there!
Full disclosure: short USD/CAD