What Are The Markets Facing?

The release of Canadian consumer spending data is likely to add to evidence suggesting that the Bank of Canada will leave rates unchanged going forward, and may even consider raising rates. Canadian retail sales are anticipated to jump 0.6 percent during the month of May, suggesting that consumption remains strong and will be a positive contributor to Q2 GDP. Indeed, we saw that Canadian wholesale sales during the same period – a good leading indicator for the headline retail sales reading – surged 1.6 percent on the back of purchases of farm products and personal goods, such as apparel and household products. However, there are downside risks for this retail sales report as well. During the month of May, gasoline prices rocketed higher and in June, the unemployment rate ticked higher to 4.2 percent from 4.1 percent. Nevertheless, the odds are in favor of a strong Canadian retail sales report, which will only serve as a reminder of the Bank of Canada’s more aggressive stance in their policy statement last Tuesday, when the Bank left rates steady at 3.00 percent. The Bank identified three issues affecting the economy: the US economic slowdown, the financial market turmoil, and rocketing commodity prices. While the first two had developed in line with the expectations outlined in the April Monetary Policy Report, the latter has been stronger than anticipated and as a result, "total CPI inflation over the next year is expected to be much higher than projected at the time of the April Report." Clearly, the Bank of Canada now holds a much more hawkish bias than previously held, and there is some potential that they will consider a rate hike later in the year. In fact, in 2004, the Bank of Canada cut rates three times between January and April, only to turn around and start raising rates in September. As a central bank that has changed the course of monetary policy rather quickly in the past, it is obvious that the threat of a rate hike later this year is very real.

Bonds – 10-Year Canadian Government Bond Futures

Canadian government bonds have pulled back from resistance at 119 in recent days, and if May retail sales can put forth evidence that the consumer may be able to sustain the Canadian economy, the contract could tumble toward 117. Anything less than expected, however, may give traders all the evidence they need to start pricing in another rate cut and CGBs could target 119 once again.

FX – USD/CAD

USD/CAD continues to consolidate within a wide range of 0.9850 – 1.0350, but over the course of the past week, the pair has shown hesitance to break below near-term support at the psychologically important parity mark, where we also have the 200 SMA. Nevertheless, according to Technical Strategist Jamie Saettele, the odds are in favor of a USD/CAD decline below 1.00 in the near-term before the pair rallies higher. Will upcoming Canadian event risk work in favor of this scenario? Possibly, as Canadian retail sales are expected to rise upon release. This news will likely exacerbate concerns that a hawkish Bank of Canada may consider raising rates at some point this year. As a result, there is some potential that we could see USD/CAD break below near-term support to target a rising trendline near 0.9900. On the other hand, softer-than-expected retail sales could propel USD/CAD higher, as the data would suggest that conditions in the Canadian economy are far from buoyant.

Equities – S&P/TSX Composite Index

Canadian equities have plummeted in recent weeks after the S&P/TSX formed a triple top near 15,100. However, the 61.8% fib of 11,986.85 – 15,158.73 at 13,198.51 has thus far served as decent support, as the index has climbed in over the past week. Upcoming event risk includes the release of Canadian retail sales, which is expected to reflect a pick up in consumption. If the index rises in line with expectations, the S&P/TSX could continue climbing toward trendline resistance at 13,800. On the other hand, weaker-than-expected retail sales could send Canadian shares dipping back down toward 13,500 or lower.

Terri Belkas is a Currency Strategist at FXCM.