The Canadian dollar got hit last week as BoC Governor Stephen Poloz’s comments were seen to be dovish.
Poloz said that he could not rule out interest rate cuts. However, he said that it would first require the balance of risks for the inflation outlook to shift to the downside. The Governor also emphasized that the central bank currently has a neutral bias.
Our FX strategists think the market is pricing in an overly benign outlook for Canadian short term interest rates. Canada has a much smaller output gap than the U.S. Therefore, Canada is likely to hit capacity constraints sooner. In order to keep inflation in check, the BoC will need to normalize policy ahead of the Fed. Meanwhile, Canadian household debt continues to rise and the housing market remains frothy. Last week’s data showed that average house prices were up 10% yoy in February.
It may take a re-rating of BoC rate expectations or Chinese reflation for USD/CAD to head lower. Oversold technical indicators warn against putting on fresh C$ shorts.