What Are The Markets Facing?

In a Bloomberg News poll of 25 economists, all but one expects the Bank of Canada to cut rates by 25bps on Tuesday to 2.75 percent, the lowest target rate since September 2005. The growth outlook has diminished for the country as expectations grow that emerging market demand for Canadian’s natural resources will start to diminish as the effects of the U.S. slowdown filters through those economies. The country has been the beneficiary of the recent commodity boom which has allowed it to weather the headwinds from the U.S. to this point. This was evident when the International Trade Balance rose to its highest level in 10 months in March. However, April figures are expected to show a reduction to C$5.0 billion from C$5.5, underlying the central bank’s concern. Furthermore, recent economic indicators including Ivey PMI, employment data, have pointed toward some slowing in domestic demand, and growth in the first quarter contracted 0.2% which only gives the Bank of Canada the green light to slash rates.

Bonds – 10-Year Canadian Government Bond Futures

Canadian government bonds bounced from the Fibonacci support at 117.00/03 and is about to break through resistance at the 100 Day- SMA. 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 119.20, with a clear break above 100 SMA suggesting that more gains could be in store. On the other hand, if the Bank leaves rates unchanged, CGBs could test 116.75.

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, sparked by a contracting growth report and a disappointing employment print, which has seen the pair rally over 200 points. According to Technical Strategist Jamie Saettele, 1.0324 is the target, but traders should look to start taking off some longs. 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 pauses their easing the loonie 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 $138/bbl, leading to the index setting a record high of 15154 on June 6. A rate cut from the BoC may send equities to set a fresh high as a lower risk free rate will raise valuations. However, coming off a record high the index may be set up for a retracement; especially given that the impetus for a rate cut is a slowing economy. A rate hold would signal that inflation concerns are mounting, which could weigh stocks as consumers may curb spending.

Terri Belkas is a Currency Strategist at FXCM.