CAD Retail Sales (MoM) (NOV) (13:30 GMT; 08:30 EST)
Expected: 0.3%
Previous: 0.1%

Bank of Canada Rate Decision (14:00 GMT; 09:00 EST)
Expected: 25bp Cut to 4.00%
Previous: 25bp Cut to 4.25%

What Are The Markets Facing?

On Tuesday, the Bank of Canada will announce whether they find it necessary to cut interest rates by another 25bp to 4.00 percent, as downside risks to growth continue to mount and credit markets remain tight. Indeed, there is much evidence that points to a potential cut, helping to explain why futures are pricing in such a move and all of the 18 economists polled by Bloomberg News agree that they will do so. Economic expansion in Canada slowed during the third quarter to 2.9 percent from 3.8 percent during the quarter prior. The trade component created a drag on the headline figure, as the appreciation of the Canadian dollar led exports to slow to 2.3 percent from 3.1 percent. On the other hand, the national currency's gains helped business investment to jump and pick up some of the slack of the trade figures, as businesses were quick to take advantage of cheaper machinery and equipment prices in the US. Meanwhile, Canadian labor market deteriorated at the end of the year, which may only lead retail sales to soften further. The combination of slowing expansion led by lackluster demand for Canadian exports and faltering domestic demand would be enough on its own to spark expectations for a rate cut by the BOC. However, November inflation readings showed surprisingly weak core figures, as the Loonie’s gains led the costs of imported goods to plummet. In fact, the BOC’s CPI measure went unchanged during the month, bringing the annual rate further below their inflation target to 1.6 percent. Furthermore, the central bank’s quarterly Business Outlook Survey showed that 32 percent of executives said credit markets had tightened in the past three months, highlighting the fact that businesses are struggling to raise funds. As a result, the BOC will likely follow the US Federal Reserve’s lead and make monetary policy more accommodative, which may spark major volatility in the nation’s bond, FX, and equity markets.

Bonds – 10-Year Canadian Government Bond Futures

Canadian Government Bond futures are down slightly from this week's high of 117.14, which is slightly above weekly pivot resistance at 117.10. However, Wednesday’s bearish engulfing candle does not bode well for this bull run, and declines may target Initial support at 116.33-55. Nevertheless, Tuesday’s BOC rate decision provides ample event risk for CGBs, as a rate cut is likely to push the contract towards 117.19. On the other hand, a surprise decision to leave rates steady could weigh heavily on CGBs.

FX – USD/CAD

The Canadian dollar has lost steam over the past few months since the USD/CAD pair bottomed out at 0.9059 on November 7. While the greenback has generally gained against most of the majors during that period of time, signs that the strength of the Canadian economy is waning have only helped accelerate the rebound in USD/CAD. Recently, the pair managed to push above the critical 1.00 level, but whether the Loonie will hold below parity remains to be seen. On Tuesday, the Bank of Canada will announce their interest rate decision, and the markets are betting that they will cut lending rates by 25bp to 4.00 percent. Given signs that economic and financial market conditions are deteriorating, there is little doubt that the Bank of Canada will at least issue a somewhat dovish policy statement.

First, an actual rate cut by the central bank will lead USD/CAD to surge towards resistance at 1.0340, though the gains could be more severe if the policy statement makes it clear that a rate cut may be implemented during their next meeting in February. This would not be completely out of the norm, as the May 2007 policy statement gave a clear nod to the potential need for a rate hike when they said, “some increase in the target for the overnight rate may be required in the near term.” On the other hand, if the Bank of Canada maintains that “the current level of the target for the overnight rate is consistent with achieving the inflation target over the medium term” without citing downside risks to inflation or growth, USD/CAD could actually fall lower.

Equities – S&P/TSX Composite Index

The S&P/TSX Composite index has been in a free fall on US recession concerns, as the index comes off a third straight day of triple digit declines and hit its lowest close since early March 2006. International investors have been selling off Canadian equities in anticipation of a global economic slowdown and the corresponding reduction in demand for commodities, which has been fueling Canada’s recent run of growth. Considering last time they cut rates the index dropped 100 points, look for the BoC to throw another log on the fire as they are expected to cut rates by another quarter point to 4.00 percent. However, don’t expect for the index to react much differently if the bank unexpectedly keeps rates unchanged, as the US, Canada’s main trading partner, continues to spiral towards a recession.

Terri Belkas is a Currency Strategist at FXCM.