Market Briefing: Canadian Dollar Drops as Traders Question Rate Hike Sustainability
The Canadian dollar is trading on a slightly weaker footing after Statistics Canada reported the first loss of jobs in nine months, suggesting that the economy was beginning to struggle with higher borrowing costs ahead of this week’s rate hike. The country lost 17,300 jobs in May and the unemployment rate ticked up to 5.2 percent from 5.0 percent as the part-time, self-employed, and services sector categories moved into contraction. The number of hours worked (sometimes a better read of underlying conditions) fell 0.4 percent month-over-month, and wages grew 5.1 percent year-over-year, down from 5.2 percent in the prior month. We think the loonie, and yield differentials - which represent the gap between US and Canadian rate expectations - are likely to correct further from Wednesday’s blowout as investors lower odds on Canadian outperformance in the latter half of the year.
In a speech given yesterday, Bank of Canada Deputy Governor Paul Beaudry warned the country might have “entered a new era of structurally higher interest rates,” as a series of disinflationary trends reverses across the global economy. Speaking in Victoria, British Columbia, Beaudry said aging demographics in the West and China are raising the cost of workers and capital, that falling inequality could impact the allocation of resources, and that investment levels might climb as demand returns and the renewable energy transition accelerates. In rationalizing Wednesday’s rate hike, he said “The accumulation of evidence - across a range of economic indicators - suggests that excess demand in the Canadian economy is more persistent than we thought, and this increases the risk that the decline in inflation could stall. That’s why we decided to raise the policy rate”.
The dollar is slightly weaker and yields are down after the number of first-time applications for unemployment benefits jumped by the most since July 2021, raising concerns about an incipient employment slowdown. Data released yesterday showed 261,000 initial jobless claims submitted in the week ended June 3, up from 232,000 in the prior week. A rise in unemployment is almost inevitable in coming months, but unpredictable factory shutdowns, seasonal adjustments, the Memorial Day weekend, and state-level claims fraud are all likely to have played havoc with the data - making it unlikely (in our opinion) to sway policymakers at the Fed.
The day ahead should be relatively quiet: there are no major data releases scheduled, and this afternoon’s Baker Hughes rig count should leave markets unmoved.
But next week will be incredibly active: The UK should kick things off on Tuesday with a small rise in the unemployment rate and a big jump in private sector wage growth - factors that might firm market odds on a June rate hike while raising questions around August. US consumer prices - reported shortly thereafter - could cool in May, with both headline and core measures decelerating month-over-month as goods demand weakens, gas prices fall, and rents normalize. Retail sales on Wednesday could exhibit similar dynamics as households pull back on large discretionary purchases.
Markets are assigning circa-80-percent odds to a pause at the Federal Reserve’s Wednesday decision, but a hawkish slate of accompanying forecast updates could put upward pressure on expected yields through the back half of the year. Investors will parse the Statement of Economic Projections - colloquially known as the “dot plot” - carefully for insight into whether a split is likely to emerge among participants on the rate-setting committee. Although Chair Powell and other moderate centrists have said they think previous tightening efforts are only beginning to feed through into the economy, more hawkish officials have warned robust demand and persistently-elevated inflation rates are likely to force rates higher - and this difference of opinion could drive median forecast dots above levels previously suggested.
In contrast, the People’s Bank of China might deliver a psychologically-important rate cut. Sources cited by Bloomberg and others suggest that recent efforts at verbal suasion - officials have reportedly asked major banks to slash borrowing costs - could be followed by a 0.10-percent reduction in the benchmark one-year medium-term lending facility rate on the 15th. This would be largely symbolic, but might help lift animal spirits in a country that is generating very little inflation amid a generalized deceleration in credit growth and economic activity.
Japanese policymakers are unlikely to follow suit. Core inflation measures (which exclude fresh food and energy in Japan) are still pushing higher, but Governor Kazuo Ueda has sounded resolutely dovish in recent comments, suggesting that if an adjustment in the central bank’s yield curve control framework comes - still a big if - it won’t come until new forecasts are published in July or October. The yen - which has suffered relative to the dollar this year - could come under renewed selling pressure if US rates keep marching higher.
Investors are overwhelmingly positioned for a rate hike from the European Central Bank on Thursday, so market focus will instead fall on what policymakers have to say about the future. We think growing evidence of a broad-based slowdown will force downward adjustments in growth and inflation forecasts - which should help solidify expectations for a pause after a final hike at the July meeting - but a heavier emphasis on “sticky” price pressures might wreck this view, raising the odds on a another move in September.
After successive surprises from the Reserve Bank of Australia and the Bank of Canada, traders are likely to remain jumpy throughout the week, making outsized moves (and subsequent reversals) more likely. Trading ranges could widen in several major pairs.
USD Baker Hughes Weekly Rig Count
GBP Claimant Count Rate, May
GBP Payrolled Employees Monthly Change, May
USD Consumer Price Index Index, May
GBP Trade Balance, April
GBP Monthly Gross Domestic Product, April
USD Department of Energy Weekly Inventories
USD Federal Reserve Rate Decision
USD Federal Reserve Press Conference
JPY Bank of Japan Rate Decision
CAD Housing Starts, May
EUR European Central Bank Rate Decision
USD Weekly Jobless Claims
USD Retail Sales Advance, May
EUR European Central Bank Press Conference
CAD Existing Home Sales, May
USD New York Federal Reserve Services Business Activity, June
USD University of Michigan Sentiment, June Preliminary
USD Baker Hughes Weekly Rig Count