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Canadian Dollar weakens as markets reluctantly accept Fed's forecast for rate cuts

Published 2024-02-28, 05:53 p/m
Updated 2024-02-28, 05:53 p/m
© Reuters. – The Canadian dollar weakened against its U.S. counterpart today, weighed down by risk-aversion and

The U.S. dollar meanwhile was broadly higher as sentiment turned risk-off following the second revision of U.S. fourth-quarter GDP data.

The second estimate released by the Bureau of Economic Analysis showed that the U.S. economy grew at an annual rate of 3.2% in Q4 2023. The data indicates continued strength in the U.S. economy, and reinforces the implication that the Fed will not need to rush to cut rates.

Swaps data now shows that bond traders no longer expect that the U.S. Federal Reserve will lower interest rates by more than 75 basis points this year - now bringing expectations in line with the Fed’s own projections.

The December release of the Federal Open Market Committee's Summary of Economic Projections showed that policymakers expected Fed funds to fall by 75 bps in 2024. Disbelieving markets, however, proceeded to price in 150 bps of cuts from the Fed for the year.

Since then, a plethora of robust U.S. economic reports and indicators of stubbornly higher than expected inflation report have led markets to push back and pare down expectations of rate cuts from the Fed.

The Canadian dollar meanwhile has come under pressure from weak economic data in recent weeks, and a cooler than expected CPI release, which have served to bring forward bets of a rate cut from the Bank of Canada to April.

Looking ahead for the pair, markets will be watching Canadian Q4 GDP data on Thursday, a key data point the Bank of Canada will use to guide its rate cut trajectory and timeline. Expectations are for an annualized increase of 0.8% in the quarter.

The GDP print should have a limited impact on the loonie, notes Simon Harvey, Head of FX Analysis at Monex Europe. Harvey writes that the GDP print “Should not overly trouble the loonie in our view, with consensus predictions looking for a print that shows Canada escaped a 2023 recession… this should keep the BoC on track to ease policy in April, in line with our base case but a sharp contrast to current market pricing.”

“As such, we see a significant amount of risk building around next week’s BoC meeting, with the potential for an explosive upwards move in USDCAD if market expectations are forced to rapidly realign.”

Tomorrow's release of U.S. PCE data, the Fed’s preferred measure of inflation, will also be a key driver for the USDCAD pair.

Erik Bregar, director, FX & precious metals risk management at Silver Gold Bull inc notes that if PCE “comes in hot, I wouldn’t be surprised to see [U.S.] yields extend higher … and CAD suffers again.”

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