BlackRock Says Market Being Too Aggressive in Pricing Canadian Hikes

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  • Canada to hike just once more this year, if at all, firm says
  • Loonie will struggle for traction absent BOC tailwind: Pimco

The world’s biggest money manager is breaking from consensus, saying the Bank of Canada will increase interest rates only once more in 2018 -- if that.

While none of the 21 analysts surveyed by Bloomberg expects a hike at Wednesday’s central bank announcement, strategists and traders remain convinced that officials are on course to raise rates at least two, and potentially three more times before year-end.

Yet concerns over household debt, investment activity, business formation, and trade will prompt BOC governor Stephen Poloz to stand pat until the second half, according to Aubrey Basdeo, head of Canadian fixed income at BlackRock Inc. Even then, he predicts one rate hike at most before the year is out. That would be a change of pace for a central bank that’s tightened monetary policy at three of its past five meetings, spurred on by strong growth and a surge in employment.

“The market is being too aggressive for what we’ve seen so far,” Basdeo said. “That market reaction is tied more toward what’s likely to happen in the U.S. -- that is, the fiscal impulse generates strong growth there and we benefit from that.”

A less hawkish BOC wouldn’t bode well for a Canadian dollar that’s already the worst performing Group-of-10 currency this year. The loonie fell to as low as C$1.2989 per U.S. dollar Friday, the weakest since July.

U.S. investors already wagering the Federal Reserve will increase rates three times this year are beginning to hedge against the likelihood of a fourth after new chairman Jerome Powell gave an upbeat assessment of the economy in front of Congress last week. While that’s more aggressive than what’s being priced for the BOC, traders remain hesitant to bet on too much policy divergence.

Participants in the market for Canadian bankers’ acceptance contracts expect officials to tighten policy by another 54 basis point by year-end, from 1.25 percent. The odds of a hike by the BOC’s May 30 meeting stand at about 50 percent, according to overnight index swap pricing. That’s down from about 80 percent after a string of recent economic data misses and the release of a federal budget that kept the fiscal deficit steady.

Red more: Fed’s haste makes Canadian debt a better bet than Treasuries

Pacific Investment Management Co.’s Ed Devlin said he also expects the Bank of Canada to take a cautious approach to policy tightening. While it’s possible officials hike twice more by year-end, the prevailing risk is for the BOC to be less aggressive than expected, not more, he said.

Without the support of a hawkish BOC, the loonie will struggle to gain traction, he added.

Ongoing North American Free Trade Agreement negotiations, which are scheduled to conclude their seventh round Monday in Mexico City, remain a likely source of volatility for the loonie over the medium-term. President Donald Trump’s announcement of duties on steel and aluminum March 1 helped fuel the loonie’s worst week in a year.

Canada has said it will strike back if the president includes them in the stiff tariffs. Senior U.S. trade advisers said Monday that Trump doesn’t want any nation exempted from the duties, set to be imposed as early as this week.

Economic Slowdown

While Canada’s economy is coming off a stellar 2017, the country shed a net 88,000 jobs in January, its largest monthly decrease since 2009, while retail sales figures released last month showed receipts fell 0.8 percent month-over-month in December. Friday’s gross domestic product figures did little to ease concerns of a slowdown, with data showing the economy growing at an annualized pace of just 1.7 percent in the fourth quarter amid signs indebted households have begun paring spending.

“We’ve come off all this strength in the data,” Brittany Baumann, a macro strategist at Toronto Dominion Bank, said before the GDP figures were released. “We’re now getting in this more moderation stage.” Baumann expects the BOC to remain on hold for at least the next two policy meetings.

The loonie’s 3.2 percent drop year-to-date is starting to leave its mark on the options market. Realized daily volatility has risen to the highest since September, and is nearly a full percent above its implied counterpart as traders become increasingly concerned about the currency’s direction.

In a sign that they’re starting to price in BOC policy risk, currency puts traded this week expiring around the March 7 meeting outnumbered currency calls by about 50 percent, according to Depository Trust & Clearing Corporation volumes. The one month 25-delta risk reversal, a barometer of sentiment and directional risk, is at its highest level since May as strikes above C$1.30 begin to accumulate. A move above this level would likely see volatility rise further.

“If the data is flagging a slowdown, then we should see a different tone from the Bank of Canada,” BlackRock’s Basdeo said. “That’ll cause the repricing of fixed income assets.”

— With assistance by Maciej Onoszko, and Robert Fullem

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