BoC shows the FOMC how to skip & hike

CAD: BoC follow the RBA in hiking ahead of FOMC pause

The Australian and Canadian dollars are now the two top performing G10 currencies on a month-to-date basis with the Bank of Canada yesterday joining the RBA in hiking this week with markets having expected another pause from both. For the Bank of Canada the data has improved and inflation has picked up but there was only about 6-7bps of tightening priced ahead of yesterday’s decision. The Bank of Canada prior was the first G10 central bank to pause and it was January when the BoC had last hiked before yesterday.

The BoC cited an “accumulation of evidence” that resulted in the BoC believing that “monetary policy was not sufficiently restrictive”. The guidance from the BoC was similar to that from the RBA in that it certainly did not suggest the hike yesterday was a one-off adjustment and stated that they would be “evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour” was consistent with price stability. Hence, further data like we have been getting from Canada may well see the BoC hike again.

The OIS market implies a 70% probability of a 25bps hike in July is now priced with 40bps of hikes priced by year-end. BoC Deputy Governor Paul Beaudry will give a speech this evening (20:25 BST) and may help shape near-term policy expectations further.

The Canada jobs data tomorrow will also be important and while the data has been stronger than the BoC expected, we are not convinced that will necessarily persist. Of course, the time to the July meeting it relatively short (12^th July) so it is certainly feasible we do indeed get another hike. But there is a danger that could be overdoing it and given Canada’s household indebtedness is greater than elsewhere, we see increased risks of that feeding through to the data relatively quickly. The move in the 2-year swap spread following yesterday’s hike is now consistent with USD/CAD trading below 1.3000 and if we then add an assumption of risk appetite remaining relatively resilient, further CAD strength over the short-term toward the 1.3000-level is very possible. However, the danger of overdoing it coupled with data turning weaker and risk appetite weakening could emerge quickly and that suggests to us that there are limits to any near-term CAD strength.

POTENTIAL DOWNSIDE FOR USD/CAD AFTER BOC HIKES

Source: Bloomberg & Macrobond

TRY: Lira plunge with change on the way  

The Turkish Lira plunged yesterday with USD/TRY over 7% higher as domestic banks pull back from selling the US dollar – a clear sign that the authorities have thrown in the towel on the unorthodox policy framework pushed by President Erdogan. Relative nominal exchange rate stability through to the election was never going to last coinciding with domestic inflation still now running at 40% after inflation of 72% in 2022. Economic imbalance is evident by the fact that annual import growth is running at 22% compared to 5% export growth. Turkey’s current account deficit is close to tripling from around USD 20bn in 2021 to approaching USD 60bn now.  

This imbalance has been manged through numerous sources of foreign currency financing plus the substantial rundown of FX reserves. Net FX reserves are now deeply negative and usable FX reserves are estimated to be no more than USD 30bn. In an economy running a deficit nearly double that, the scenario is unsustainable.  

Enter orthodox economic policies! This essentially will mean substantial rate hikes with the aim of closing the current account deficit quickly. That means a reversal of strong credit growth and weaker domestic demand. The Erdogan giveaways into the election will be no longer happening and the hope is that the policies to close the widening current account deficit will help bring about some renewed sources of USD funding over the coming months. This policy step should also help bring domestic inflationary pressures lower to help stop the sustained loss of competitiveness driven by a higher TRY in REER terms.

The Central Bank of Turkey meets on 22^nd June and the only question is whether a change in monetary policy will be left until then or announced sooner. A change in leadership seems likely first but a hefty rate increase followed by further hikes to reverse the easing to date seems inevitable (cuts began from 19.0% in March 2021). Turkey equities markets like the potential change coming with the main indices hitting new ytd highs while the sovereign CDS has fallen sharply. In our May FX Outlook report (here) we raised our USD/TRY forecasts to a level of 28.000 by end Q1 2024 in anticipation of a change in policy and reflecting the unsustainability of the current economic policy framework.

RAPID EXPANSION OF TURKEY’S CURRENT ACCOUNT DEFICIT

Source: Macrobond

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	10:00	Employment Change (YoY)	Q1	1.7%	1.5%	!
EC	10:00	Employment Change (QoQ)	Q1	0.6%	0.3%	!
EC	10:00	GDP (YoY)	Q1	1.2%	1.8%	!!
EC	10:00	GDP (QoQ)	Q1	0.0%	0.1%	!!
US	13:30	Continuing Jobless Claims	--	1,800K	1,795K	!
US	13:30	Initial Jobless Claims	--	235K	232K	!!!
US	13:30	Jobless Claims 4-Week Avg.	--	209.67K	229.50K	!
US	15:00	Wholesale Inventories (MoM)	Apr	-0.2%	0.0%	!
US	15:00	Wholesale Trade Sales (MoM)	Apr	0.4%	-2.1%	!
CA	20:25	BoC Deputy Governor Beaudry Speaks	--	--	--	!!!
US	21:30	Fed's Balance Sheet	--	--	8.386T	!!
US	21:30	Reserve Balances with Federal Reserve Banks	--	--	3.206T	!!

Source: Bloomberg