This is a week where it seemed like every asset class lost value except bonds and the Powerball lottery jackpot. The volatility of last week is now yielding our first central bank showdown of the year – at Canada’s central bank. Just a month ago, the 2016 forecast was for the Bank of Canada’s benchmark to stay at .50 percent for the entire year. Then last week, there were rumblings in the market that pressure might be building for the Bank of Canada to cut rates to .25 percent. This week, speculation is nearly reaching the frenetic levels we saw with the Federal Reserve in September 2015. Markets are about evenly split as to whether or not Canada’s central bank will cut rates next week.
Some followers of the situation are holding to the prediction for no change at the meeting next week, but most admit it is a close call.
What we’re seeing here are two competing economic factors. The bottom falling out in the price of oil is a net negative for the Canadian economy, sure. In addition, the loonie (slang for the Canadian dollar, based off the bird on a Canadian coin) has been at lows not seen since 2003.
But the depreciation of the loonie is an overall positive for the export-oriented Canadian economy. For both of those factors, the key question is “latency” – in other words, how long will it take for the effects of a weaker Canadian dollar, which was a trend that started during the last half of 2015, to permeate the Canadian economy?
The question really comes down to whether or not the economic news in Canada gets worse in the next few weeks and how that affects the micro side of the equation; in other words, how will Canadian businesses react to macroeconomic factors? As in the U.S., the first few weeks of the year are when Canadian businesses decide on their spending plans for much of the year, and it remains to be seen if this volatility shock will offset those businesses’ favorable outlooks resulting from the lower Canadian dollar.
Our View: This really is a close call, but the arguments for near-term patience still lean toward the Bank of Canada holding its course next week. Look for extraordinary scrutiny of Bank of Canada's comments and near-term data releases to determine where we go next.
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