Bank of Canada Rate Decision (13:00 GMT; 09:00 EDT)
Expected: -50bp to 3.00%
Previous: -50bp to 3.50%

What Are the Markets Facing?

In a Bloomberg News poll of 32 economists, 75 percent expect the Bank of Canada to cut rates by 50bps on Tuesday to 3.00 percent, the lowest target rate since October 2005, as inflation pressures subside, credit markets tighten, and a probable recession in the US threatens the Canadian economy. The most recent CPI report showed that the Bank of Canada’s core measure fell to 1.3 percent, which is the lowest reading since July 2005 and well below the Bank’s 2.0 percent target. During the March meeting, when the Bank cut rates by 50bps to 3.50 percent, the concurrent press release said that “the balance of risks around its January projection for inflation has clearly shifted to the downside…Further monetary stimulus is likely to be required in the near term to keep aggregate supply and demand in balance and to achieve the 2 percent inflation target over the medium term.” Furthermore, recent economic indicators including Ivey PMI, employment data, and wholesale sales have pointed toward some slowing in domestic demand, which only gives the Bank of Canada the green light to slash rates.

Bonds – 10-Year Canadian Government Bond Futures

Canadian government bonds tested the confluence of trendline and Fibonacci support at 117.00/03 on Friday as traders piled into equities. While risk trends will remain the primary driver of CGBs going forward, Tuesday’s Bank of Canada meeting could lead the contract to jump toward a zone of resistance near 118.19 - 118.41, with a clear break above 50 SMA suggesting that more gains could be in store. On the other hand, if the Bank cuts rates less than expected, CGBs could test 117.00 once again.

FX – USD/CAD

After plunging for much of 2007, USD/CAD has done nothing but consolidate its losses within a nearly 600 point wide channel of 0.9650 – 1.0250. More recently, the pair has bounced from trendline support at the psychologically important 1.00 mark, sparked by the release of surprisingly soft Canadian inflation data. According to Technical Strategist Jamie Saettele, USD/CAD could be setting up for a surge and upcoming event risk could shake up the pair. On Tuesday, the Bank of Canada is forecasted to cut rates, and USD/CAD is likely to show an immediate reaction to the 9:00 EDT announcement. If the Bank cuts rates in line with expectations and suggests that more may be on the way in their press release, USD/CAD could surge higher. On the other hand, if the Bank only cuts rates by 25bp, the Canadian dollar could strengthen significantly across the majors and weigh heavily on USD/CAD.

Equities – S&P/TSX Composite Index

The S&P/TSX Composite Index continues to surge led by energy stocks, which received a boost from record oil prices above $117/bbl. However, the threat of another bout of market-wide risk aversion creates substantial downside potential for Canadian equities, and the S&P/TSX may have trouble breaking above trendline resistance at 14,350 in the near-term. On Tuesday, the Bank of Canada’s rate decision could shake up stocks, and bearish rhetoric in the concurrent press release could lead the S&P/TSX to fall down toward the 14,000 level.

Terri Belkas is a Currency Strategist at FXCM.