Canadian Dollar hits fresh two-week lows amid higher yields, Fed hiking bets
- USD/CAD extends gains to the 1.3920 area from 1.3845 lows on Tuesday.
- Risk aversion amid higher global yields and rising tensions in Iran is boosting the safe-haven USD.
- Soft US manufacturing and jobs data has failed to dent hopes of a Fed rate hike in September.
The Canadian Dollar (CAD) depreciates against the US Dollar (USD) for the second consecutive day on Wednesday, weighed by growing risk aversion as global yields rise to multi-year highs and with expectations of an immediate Federal Reserve (Fed) rate hike providing additional support to the Greenback. The USD/CAD pair has reached fresh two-week highs above 1.3920 ahead of the Bank of Canada's (BoC) interest rate decision.
The US Dollar has regained its safe-haven status this week, as the rally in global yields pressures central banks to tighten their monetary policies and curbs investors’ appetite for risk. Beyond that, tensions in the Middle East have escalated, following a month of tense calm, altogether contributing to the risk-off market mood.
Later on Wednesday, BoC is widely expected to leave its benchmark interest rate on hold at 2.25%, and, most likely, through the rest of the year, as the tariff rift with the US and the uncertainty surrounding the Middle East conflict cast serious doubt on the country's economic outlook. This event is unlikely to provide any significant support to the Canadian Dollar.
Markets keep Fed tightening expectations elevated
In the US, data released on Tuesday showed that the ISM Manufacturing Purchasing Managers Index (PMI) slowed down beyond expectations in August and JOLTS Job Openings grew below forecasts in July. These figures, however, failed to dent the US Dollar’s recovery as investors remain confident that the Federal Reserve (Fed) will hike interest rates at its September meeting.
Strategists at Brown Brothers Harriman note that Fed funds futures now “price in 67% odds of a 25bps hike on September 16 and imply 60bps of tightening over the next twelve months.” Looking ahead, they expect that this “pricing will remain elevated into the September meeting, with the August CPI on September 11 the decisive test.”
On Wednesday, the focus will be on the US ADP Employment report, which is expected to show a net increase of 47K in private payrolls in August, following a 44K increase in July.
Central banks FAQs
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.