Canada's Dollar Sets 12-Year Low as Bets Mount on 2016 Rate Cut

Updated on
  • Traders see growing probability of BoC reduction by mid-year
  • Falling crude oil, signs of China weakness drive wagers

Derivatives and currency traders see a growing chance that the Bank of Canada will drop interest rates back to a record low this year as the economic outlook dims abroad and at home.

The Canadian dollar fell to a 12-year low Wednesday and traders started pricing in a 50 percent chance of a rate cut by May, up from the 31 percent probability seen on Dec. 31, amid signs of economic weakness in China and declines in the price of oil, among Canada’s largest exports.

The Bank of Canada is counting on export growth and stability in crude prices to revive the economy after what may have been the slowest annual expansion since 2009. Yet speculation is brewing that policy makers will drop their target rate a quarter-point to 0.25 percent, where it bottomed in 2009-2010. Private data this week showing Chinese manufacturing contracted the past 10 months renewed questions about global demand for crude, which is almost 30 percent weaker than a year ago.

"Maybe we’re underestimating how weak emerging markets will be to start the year; that’s something that would weigh on Canada too," said Mark Chandler, head of Canadian fixed-income strategy at Royal Bank of Canada’s RBC Capital Markets unit in Toronto.

The Canadian dollar traded at C$1.4072 per U.S. dollar at 8:40 a.m. in Toronto, after touching C$1.4109, the weakest since August 2003. It bought about 71 U.S. cents.

Commodity Crossroads

The loonie, named for the bird engraved on the dollar coin, fell the past three years. It suffered its biggest drop since mid-December on Monday amid a global equities rout that started in China, the world’s second-biggest economy. Currencies of commodity-dependent countries such as Australia and New Zealand also slid Wednesday.

A year ago, the Bank of Canada used its first meeting of 2015 to announce a quarter-point rate cut as crude oil plunged, and it lowered borrowing costs again in July. Trading in overnight index swaps implies a 19 percent chance of a reduction this month, and the probability rises to about 50 percent for May.

That’s counter to the consensus among economists, who expect the bank’s target to stay at 0.5 percent through 2016, according to the median estimate in a Bloomberg survey.

Pessimism Renewed

Pessimism toward the loonie and prospects for Canada’s economy has deepened to start the year as oil sank below $35 a barrel.

"If China is shifting to a structurally lower rate of growth that means commodity prices will probably fail to rebound,” said Vassili Serebriakov, a foreign-exchange strategist at BNP Paribas SA in New York. “With Canada being kind of a major oil exporter, that’s a very relevant factor."

In his last public appearance Dec. 15, Bank of Canada Governor Stephen Poloz reiterated his view that economic growth would slow in the fourth quarter before reviving on gains in non-energy exports. He’s set to speak in Ottawa on Thursday. 

The Canadian dollar’s slide to start the year follows economic indicators suggesting the country ended 2015 growing more slowly than the rate of expansion that the central bank has projected for last quarter.

Analysts forecast that Canada managed 1.2 percent growth last year, the weakest pace since a 3 percent contraction in 2009. Investors are looking to this week’s release of December labor data for more insight into the economic outlook. The nation probably added jobs last month, following a decline in November, according to the median projection in a Bloomberg survey.

"We are clearly tracking growth for the fourth quarter below what the Bank of Canada had anticipated," said Andrew Kelvin, senior fixed-income strategist in Toronto at Toronto-Dominion Bank. "That opens up a reasonable possibility of seeing a rate cut in the first half of this year."

— With assistance by Andrea Wong

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