Canada and CAD are the least important aspects of today’s Bank of Canada meeting
Today’s BOC meeting may have far greater consequences than just what affects Canada
Obviously not dismissing the trading impact of the BOC on CAD, or Canada in general but that may not be the big news. There’s many folks thinking that the BOC will try and rein in hawkish market expectations for rates next year. Expectations are for the taper to continue, with another cut seen coming today, perhaps alongside a final end date being delivered, and how they’ll manage reinvestments/the balance sheet thereafter. Like we’ve seen across the central bank space, the market is looking for those rate hike clues too.
That’s all well and good but there’s more at play here that could make bigger market waves. The BOC is one of the banks out in front for ending emergency measures and moving back towards normalisation. It could also be one of the first major banks to start detailing its thinking about the possible ‘bottleneck slowdown’. This is a subject we’ve been warning about for months now, that an economic slowdown is possible, driven by supply issues (rather than demand) that will physically affect output. We’re starting to see the early signs of that and already CB’s and governments are warning on growth into the end of the year.
How central banks deal with that is going to be important and if the BOC are first to touch on it and give a view, that could have big consequences for expectations for all the other central banks. These slowdowns will cause a drop in activity but as we know it’s not a demand issue, CB’s can well sit back and say they’ll ride it out as when bottlenecks ease, there should be a strong snap back. However, what central banks should do and what they actually do are often worlds apart, hence why what the BOC may say today is hugely important.
There’s pretty much only 2 scenarios for this.
1 – They call it transitory.
If the BOC say they recognise that these supply issues will negatively effect the economy but they see them as temporary, and are therefore happy to maintain their current path for policy, then all is good, and the market will carry those thoughts across to other CB’s and brush it all under the rug.
2 – They see a slowdown as a serious issue they need to deal with.
This is where things will get interesting. If they worry about a supply-driven slowdown, and mention that that may cause them to change their view on the current path for policy (slower taper, stopping the taper, increasing QE again, pushing rate hikes further back) that’s potentially going to cause some big waves for market expectations for all the other CB’s too. If the BOC get worried and turn more dovish on a slowdown, the market will think the Fed, the ECB, the BOE and all the others will follow suit, and given that the market is getting hawkish over those, that would likely cause a massive reprice of expectations.
This is why this central bank meeting is far more important than just what it means for Canada, and that’s a risk that can’t be ignored today. Of course, the market will decide what it wants to do today and it may not yet even be thinking about possible CB reactions to an impending slowdown but as traders, it’s our job to run the rule over any possible risks surrounding these types of events. It’s best to know your risks, even if they don’t happen than to take a knock after the event because you weren’t aware of something.
For trading this, I think maybe the market might be setting itself a little too cautiously on whether the BOC rein in the current expectations, and so there’s a price risk there if they stick to the script or are a touch more bullish Canada/hawkish policy, so in that outcome CAD could run higher. If we get scenario 2 above, I think things could become much more complex and a CAD sell off might morph into more of a broad risk off move as the market reprices other CB expectations. It could get quite messy but that’s a potential move I might look to counter because while demand remains, the ‘bottleneck slowdown’ should ease and then CB’s will be forced to change tack again. In the case of the first instance, that might be a shorter-term move but for the second instance, that might be better traded over a longer timeline. Some of these ideas are already being drawn up in our traders chatroom.
Even if the BOC don’t make any song and dance over a slowdown, the issue won’t go away so we’ll have to then see if the others get on the subject too. For now, we’ll just hear what the BOC have to say and trade/analyse it all accordingly.