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FOMC minutes infocus, BoC to stay on hold
BoC to stay on hold, USD/CAD subject to downside pressure
The Bank of Canada (BoC) is broadly expected to leave its benchmark rate unchanged at 0.50% today. The central bank will go on with its neutral approach as Governor Poloz does not want to derail the ongoing recovery. Despite a setback in the first quarter, inflation has been slowly moving toward the centre of the target band. On the growth side, the Canadian economy has been able to maintain a positive momentum and grew 2.5% y/y in February.
Besides the highly uncertain oil prices path, the President Trump threat remains one of the main concerns. After introducing tariffs on timber imports from Canada, a re-negotiation of NAFTA will be another painful shock for the economy. Therefore, we anticipate that the BoC will mainly stress the uncertainties surrounding the inflationary outlook and the threat of a tighter trade relationship with the US.
USD/CAD’s reaction should remain limited. The currency pair is currently erasing early morning gains and returned to 1.3510. We remain bullish on the pair as we expect market participants will slowly start to switch attention towards the Fed’s tightening path and reload bullish bets on the greenback.
China’s ratings cut
As expected, Moody’s has downgraded China’s sovereign credit rating to A1 from Aa3 with revised outlook stable. According to Moody’s, the cut was due to growing leverage and the fact indirect liabilities will be pressured as economic growth decelerates. However, the upgrade to a stable outlook indicates that at A1, the risks are balanced.
China's Ministry of Finance was quick to reject Moody’s assessment on the grounds that local government and SOE debt should not be considered obligations of the federal government. Markets will be watching the S&P rating for a probable reaction as China still has an AA- credit rating and negative watch. While the credit rating cuts failed to hurt China's stock markets, AUD headed lower following industrial commodities weakness and risk in China.
In our view the probability of a full blown collapse is low considering their ability to control capital flows. However, today's rating move is another warning shot from the markets that pace of credit growth and sustainably of debt is worrying. It is uncertain whether China authorities have the nerve to tighten further at the risk of damaging already weak economic growth.
Oil upside limited
OPEC's meeting tomorrow is expected to see a 9-month extension to the production cut agreement. We suspect that much of the production cuts are already priced in as WTI climbed from $44 to $51.60 since 5th May. Clearly a no-extension result would deliver an asymmetrical negative reaction, while an unexpected deeper cut would send oil higher.
With expectations elevated and further crude price gains unlikely, watch for oil sensitive currencies RUB, CAD and NOK to fall back. In addition, the US budget proposed to sell 270 million barrels of oil from the Strategic Petroleum Reserves over the next 10 years. Traders will be watching US crude inventories today. Given our negative oil outlook (past production cuts deals have only had a transitory positive effect on prices) and a more optimistic view on EU inflation, we would trade long EURNOK.
Markets expect upbeat FOMC meeting minutes
Today will be released the FOMC meeting minutes. Traders will monitor carefully any further hint about the Fed rate path until the end of the year. For the time being, markets are expecting an optimistic tome from May’s FOMC policy meeting.
Next US central bank’s meeting will be held the 14th of June. A rate hike probability is around 88.8% according to the OIS (Overnight Index Swap). It may be surprising that markets are overly optimistic despite last week’s strong arising political uncertainties and the Trump issue with the FBI.
Markets seem clearly skewed towards a rate hike, by moving (slightly) away this week from gold which prices have been declining since the start of the week losing -0.5% in the last 3 days. The US 2-year government bond rose to 1.32 Treasury yield and the US dollar is getting stronger.
Anyway, Fed’s Bullard – President of the St Louis Federal Reserve – is concerned by the weak March data and believes that the Fed rate path for this year is maybe too aggressive. When looking at the US Equity Markets, we may believe that the era of low interest rates is far from over. The S&P 500 is back around 2’400 points. We reload very short-term dollar position, the time that the EURUSD to head back towards 1.10.