Fundamental analysis

USD/CAD: US dollar hit by Bank of Canada’s surprise dovish move

The Bank of Canada disappointed USD/CAD bears yesterday by increasing the interest rate by only 50 basis points, falling short of the 75 bps rise expected by most economists. Afterwards, the Canadian dollar lost 100 points, and the pair reached 1.3649. However, USD/CAD bulls failed to hold onto their gains due to the weaker US dollar. In several hours, bearish traders pushed the pair down and hit the intraday low.

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The Canadian regulator’s actions have heightened the concerns of economists that have been lingering over the past two weeks. A 50 bps move by the Bank of Canada has led to speculation that the Federal Reserve would make a similar decision in December. The Canadian central bank has become the second major regulator that has slowed down the pace of monetary tightening. Earlier, the Reserve Bank of Australia moved the rate up by only 25 basis points. Market players expected the RBA to hike the rate by 50 bps.

The US dollar index predictably accelerated its decline following the Bank of Canada’s meeting. Market players have assumed that the Federal Reserve would have to similarly slow down its monetary tightening after November’s meeting. This conclusion could be quite hasty and subjective. Nevertheless, the surprise dovish move by the Bank of Canada impacted the US dollar more than its Canadian counterpart, as indicated by yesterday’s performance of USD/CAD.

However, following the initial emotional reaction, USD/CAD bears rushed to close their short positions, which ended the downward momentum. Traders are holding onto USD in the run-up to the Fed meeting in November and the monetary policy decision next Thursday. If all Fed policymakers confirm their hawkish stance, then it will mean that there is a policy gap between the Fed and the Bank of Canada. There are no objective conditions for the Fed to slow down the pace of monetary tightening at this point. The supporters of this scenario point to the decline of many macroeconomic indicators and the risk of recession. However, the biggest counterargument here is the position of Jerome Powell, which he has reiterated several times before. The Fed chairman declared he would maintain a hawkish policy course, despite the economic growth slowing down. In early autumn he surprised markets with his hawkish and even uncompromising attitude – he emphasized that the Fed would not be swayed by a possible slowdown in the labor market and other such side effects. The central bank will continue increasing the interest rate at a pace required to solve the problem of high inflation.

The factors that caused the US dollar’s retreat this week are rather shaky. If these factors lose power following the November’s policy meeting, USD/CAD bulls could once again push the pair skywards.

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It should also be noted that the October’s meeting of the Bank of Canada was markedly dovish. Besides slowing down the pace of interest rate increases, the regulator’s governor Tiff Macklem said that the tightening phase “will draw to a close”. “We are getting closer, but we are not there yet,” he added. According to Macklem, the central bank decided to slow down the pace of rate hikes due to growing concerns over a deteriorating global economic backdrop. He added that the Bank of Canada was trying to balance the risks of under- and over-tightening, saying that there were no easy ways to restore price stability.

In general, the results of the October meeting suggested that the Bank of Canada will also increase the rate by 50 basis points at the next meeting, which will be the last one this year. In the meantime, the Fed still intends to keep the 75-point hike pace, at least in November. The probability of a 75-point rate hike in December is now estimated at only 42%. After the November meeting, however, traders may revise their forecasts upward. Last week the probability of such a move stood at 70%.

In conclusion, the Bank of Canada has slowed down the pace of monetary tightening, stating that it was getting closer to the end of the tightening cycle. Its US counterpart, the Federal Reserve, will increase the rate by 75 bps in November, and will likely do so again in December. All speculation about a possible dovish turn are only rumors and assumptions. Fed policymakers cannot comment on them because of the 10-day blackout period before the policy meeting.

This situation suggests that USD/CAD still has potential for recovery. The current slump could be used for opening long positions. The first and currently the main target is located at 1.3700, where the medium band of the Bollinger Bands indicator matches the Tenkan-sen and Kijun-sen lines. The next target is at 1.3900, the upper band of the Bollinger Bands on the D1 chart. However, it is currently too far away for USD/CAD.

The material has been provided by InstaForex Company – www.instaforex.com


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