Interest rate differentials may be less supportive, but short positions in AUD/CAD are still warranted.
B oth the Bank of Canada (BoC) and The Reserve Bank of Australia (RBA) remained on hold at their respective policy meetings this week. In addition, forward guidance of the relative banks is more in step than in recent months.
The BoC made it clear that the next move in interest rates is up, with only the timing of future action still somewhat uncertain:
To the extent that the economic expansion continues and the current excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 per cent inflation target over the medium term.
Meanwhile, the RBA projected a more neutral stance than in its past meetings:
With inflation expected to be consistent with the target and growth close to trend…the stance of monetary policy remained appropriate.
Nonetheless, there is still scope for further AUD/CAD downside. Our purchasing power parity model shows that AUD/CAD is overvalued by close to 10%, which is near historic highs. In addition, Australia is more sensitive to base metals, whereas Canada is more dependent on energy, so the breakdown in the relative performance of global materials to energy stocks should be bearish for AUD/CAD.
Bottom line: Although interest rate differentials are less supportive, short positions in AUD relative to CAD are still warranted. The biggest risk to this position is if China introduces aggressive reflationary policies, which would disproportionately benefit the Australian dollar.
About BCA Research
