BoC Rate Decision (14:00 GMT; 09:00 EST)
Expected: 3.75%
Previous: 4.00%

What Are The Markets Facing?

The Royal Bank of Canada is expected to ease rates by 25 points from 4.00% at its next monetary policy meeting. Expectations are increasing that a 50 point cut may be in store, as a U.S. downturn is weighing on the Canadian economy. Declining U.S. exports resulted in GDP falling 0.7 percent in December, which is its slowest pace since 2003. Governor Mark Carney will have to decide if a strong labor market and domestic demand - which has led consumers to post four consecutive months of increased in retail sales- will be enough to buffer his economy from a U.S. recession. The other question is whether rising commodity prices and global demand for them can offset the downside risks of declining US exports. Easing inflation has given the BoC the ability to cut rates without the fear of creating stagflation, which is juxtaposed to the situation the Fed faces. Therefore, they may be aggressive and try and surprise the markets with a 50 point cut, in hopes that it will provide the necessary growth and end their need for further cuts.

Bonds – 10-Year Canadian Government Bond Futures

Risk-adverse traders have bid up the CGB through resistance at 118, reaching the highest level since 1998. As a global selloff of equities continues there appears to be little resistance to this rally. An expected BoC rate cut will only strengthen the bull’s case and may push the contract through 119. The only chance of derailing this rally would be if the BoC surprisingly left rates unchanged.

FX – USD/CAD

Close attention will be paid to the Royal Bank of Canada Tuesday as it will be deciding what direction to take its overnight lending rate. In a Bloomberg News survey, 13 of 25 economists are predicting a cut of 25bps from the current level of 4.0%. RBC Governor Carney has already signaled that easing might be necessary as Canada is facing its worst export slump in a decade. Meanwhile, the USD/CAD pair fell below the 9750 support level breaking from its three month trend channel, as the loonie rally was fueled by rising commodity prices and a broad based dollar sell off. A BoC rate cut could rally the greenback and send the pair back to parity, especially if the BoC surprises with a 50 point cut. If the BoC holds rates steady then expect the pair to break support and head lower. Discuss the topic with other traders and DailyFX analysts in the USD/CAD Forum.

Equities – S&P/TSX Composite Index

The S&P/TSX ended last week dropping nearly 300 points, as risk aversion gripped the markets on concerns that the subprime crisis hasn’t completely played out. Traders were sent running for the safe havens of bonds and gold, when AIG announced a $15 billion dollar write-down. The index had been in the midst of a commodity driven rally as growth in developing nations is expected to continue their appetite for natural resources, which saw the index rise over 1500 points since the January 22 low of 12011. As the U.S., Canada’s main trading partner, continues to show signs of a recession it will continue to weigh on Canadian Equities and may send the index below its current trendline resistance. The expected 25 point rate cut from the BoC shouldn’t be enough to give stocks a boost as the global equity selloff should outweigh its impact. However, if the BoC surprises with a 50 point cut-which the odds have increased after GDP severely disappointed- it may inspire traders to shed their risk adverse sentiment and reverse last week’s losses.

Terri Belkas is a Currency Strategist at FXCM.