How should BoC approach likely Fed rate cut?

How should BoC approach likely Fed rate cut?

How should BoC approach likely Fed rate cut?

The Bank of Canada faces the tricky task of not sounding too hawkish on the eve of a likely interest rate cut by the Federal Reserve on July 31.

Brian D’Costa, co-founder and president of Algonquin Capital in Toronto, expects Governor Stephen Poloz to hold the benchmark rate at 1.75% tomorrow and remain consistent with his wait-and-see policy after the economic weakness in the second half of last year.

While the data in 2019 is slightly stronger than expected, D’Costa does not see the BoC deviating from its stance that a rate cut of its own is “highly unlikely to be justified”.

D'Costa told WP: “The data [on the Canadian economy] is not spectacular but it’s higher, or better than, what the Bank had forecast. In that context, we think it is very likely that the BoC simply points to the slightly better economic data but also nods a hat towards the fact there are still issues in the market place, namely the trade tensions that still exist and some uncertainty around growth in the US economy, which will be enough for them to stay on hold.”

If, as expected, the Fed cuts at the end of the month, there will be a certain amount of pressure on Poloz to follow suit. However, D’Costa believes that, despite historical precedents, this is far from guaranteed.

He explained that the US has weakened due to the Fed raising rates and the effect of Trump’s tax cuts waning over time but that the country is not heading into a recession.

“What the Fed is really thinking about is taking out some insurance because they’ve raised rates and it’s not entirely sure where the neutral rate of interest is,” he said. “They are thinking we’ve raised too much, so it might be possible to make a couple of cuts as an insurance policy.

“This makes it less clear that the BoC needs to follow suit, meaning that if the US is taking steps to ensure it enjoys positive GDP, it is going to leak back into the Canadian economy.

“The important thing for investors to look for is that the Bank of Canada does not want to sound too hawkish while the Fed is easing because the concern will be around strengthening the Canadian dollar too much. It really doesn’t need the Canadian dollar to strengthen significantly and put a further dent into exports – that’s the really tricky part tomorrow.”

D’Costa reserves some sympathy for Poloz’s US counterpart Jerome Powell given the chirping from the White House. While he doesn’t believe the Fed is being influenced by President Donald Trump, he conceded the “optics are going to look pretty bad”.

He said: “Trump has been out there talking about they should be easing and the Fed is likely to deliver. I feel slightly sorry for Chairman Powell because he is going to look like he is being whipped around by Donald Trump but the data does support taking out an insurance cut.”

Not everyone is convinced the Fed will take the plunge. Michael Hewson, chief analyst at online trading platform CMC Markets, believes that last week’s better-than-expected US non-farm payroll numbers, along with a wages number that was steady at 3.1%, called into question the Fed lowering rates.

He said: “What these numbers tells us is that the pricing that a July rate cut is a done deal is anything but, and maybe investors need to start looking at the data, as opposed to hearing what they want to hear.

“This has been reflected in the reaction of bond markets, as the one-way bet that had been the prospect of lower US rates came back and slapped investors in the face as US 10-year yields snapped higher to 2.05% (on Friday). The Fed could still cut rates this year, however any more data like Friday’s will make a July rate cut a much more difficult argument to make.”

With Poloz almost certain to maintain his steady-as-she-goes approach, the potential needle-mover this month will be the US, something Kevin McCreadie, CEO and CIO, AGF Management Limited, is only too aware of.

He believes its decision this month will be critical in determining the fate of the US economy and that of the markets, pointing to the fact a decision to pause on further hikes in late December was a major catalyst for both stocks and bonds early on this year.

But McCreadie said: “Investors – and US President Trump too – have grown impatient with this stance in recent weeks and, by some estimates, markets are now pricing in as many as four rate cuts by April 2020.

“For his part, Fed chairman Jerome Powell has acknowledged one rate cut could be coming if economic conditions continue to weaken, but otherwise has remained reticent about discussing the possibility of further cuts.

''Even so, it seems almost assured that he will announce a 25 basis point cut later this month and then an additional rate cut sometime later this year. In doing so, he should appease markets – if not all of his critics – and could give stocks another large boost in the weeks ahead.

“But if the Fed doesn’t cut as expected, it could result in just the opposite, tipping off another major selloff in the process, even if the reason for not cutting is a stronger economy than expected.”

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