Given the dovish BoC call and more constructive view on the US economy, plus upside risks to the Dollar from the election, the extent of the move lower in USD/CAD looks overdone.

USD: Favor than CAD

During the past trading week, the US dollar remained under pressure following Fed Chairman Powell’s dovish comments at the August Jackson Hole Symposium. However, the bearish momentum gradually faded as several strong domestic data points revealed that the US economy remains solid and resilient, far from a recession. Notably, the August Consumer Confidence index exceeded expectations, rising to 103.30 from 101.90. Despite this, the dollar experienced a slight decline after the data release, as subcategories showed increased pessimism about future labor conditions, likely due to the recent uptick in unemployment. Additionally, consumers were slightly less optimistic about their future income prospects. Moreover, the US Q2 GDP growth was revised up to 3.0% from 1.2%. Although Q2 is in the past, the data underscores the economy’s strength, as highlighted by many companies during earnings season. Overall, the Q2 report makes it challenging to foresee a 50 bps rate cut, even if the upcoming non-farm payrolls report is softer than expected. Moreover, the July PCE, the Fed's preferred inflation measure, came in at 2.6% y/y and 0.2% m/m, indicating ongoing progress on inflation. This report gives the Fed the green light to proceed with a rate cut. The probability of a 50 bps cut is now at 30%, slightly lower than yesterday, with the upcoming non-farm payrolls report likely to play a decisive role.

Taking everything into account, with US data continuing to suggest a strong economy, the likelihood of the Fed implementing a 50 bp cut in September is diminishing, currently estimated at around 30%, with a 70% probability of a 25 bp cut. Looking ahead, markets will focus on the August Non-Farm Payroll report. Goldman Sachs expects it to be stronger than July's report, leading the FOMC to deliver a 25 bp cut in September. However, they note that a 50 bp cut could be likely if the employment report is unexpectedly weak again. Given the strong Q2 GDP, while both scenarios are challenging, neither is likely to change the narrative surrounding a September rate cut. As a result, the USD is expected to face further pressure in the near term, especially as the Fed moves closer to an easing cycle.

CAD: Further cut this week

During the past trading week, the key data point was Canada’s Q2 GDP, which came in at 2.1% q/q, up from 1.8%. However, the details revealed no growth in June and July, with most of the quarterly growth driven by government spending. This prompted a reassessment of the economic outlook, particularly in light of falling oil prices. While the headline GDP data appears strong, Canada’s broader economic picture remains one of decent growth with limited recession risks. This suggests that, when viewed independently from aggressive US money market pricing, the case for the BoC initiating an easing cycle is not compelling.

Looking ahead, markets will focus on the BoC’s September meeting and Canada’s August labour market data. The current consensus expects the BoC to cut rates to 4.25%, as slowing growth and a cooling labour market are likely to keep inflation from rebounding. The latest inflation report indicates that the BoC’s target is coming within reach. Attention will be on the statement and press conference for clues on further easing. In July, Governor Macklem suggested that if inflation continues to ease as forecasted, further rate cuts are reasonable, although the timing will depend on how the BoC assesses the opposing forces of inflation—overall economic weakness pulling inflation down, while price pressures in shelter and other services keep it elevated.

The previous BoC statement acknowledged that risks to the inflation outlook are balanced, omitting the concern about upside risks mentioned in April. Money markets currently price in 25 bp cuts at each meeting for the remainder of 2024. The July inflation data showed the BoC's core measures easing to an average of 2.43%, with the previous figure revised down to 2.57% from 2.60%, reinforcing rate cut expectations. The July jobs report saw a headline decline, driven primarily by part-time job losses, while full-time employment surged. The unemployment rate remained unchanged at 6.4%, defying expectations of a rise to 6.5%. Despite this, with slowing growth and inflation seemingly returning to target, the BoC has room to continue with 25 bp rate cuts.

Additionally, although the August labour market data will be released after the September meeting, it will be crucial in determining the future path of BoC easing and is likely to have a significant influence on meetings later in the year. Rates are currently at 4.50%, and most analysts expect rates to end 2024 at 3.75%. However, seven analysts predict rates at 4.00%, while one sees them at 3.50%. With only three meetings left in the year, including September, the majority of analysts align with current market pricing, which anticipates 25 bp rate cuts in September, October, and December. A weak labour market report could strengthen the case for more dovish policy moves.

USD/CAD 4H Chart

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