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Asymmetric risks around inflation and higher rates emerge in USD/CAD

By on February 7, 2022 0

Today’s trading highlights the danger of trading USD/CAD on fundamentals.

The pair climbed on Friday on a strong US jobs report and weak Canadian print. It made sense, but here we are today a trading day later and back to where the pair started. Not only that, but oil is down 1.4%.

Sometimes that’s the day-to-day of FX trading. The market is struggling to gauge the trajectory of rate hikes. I would also say that asymmetric risks are at the forefront.

If the peak of the rate hike cycle is 2% overnight rates in Canada and the US, it doesn’t really make a difference to the performance of either economy. However, if the terminal rates are 3-4%, the difference could be considerable.

This would certainly put pressure on both economies, but for Canada it would be fatal due to extremely high house prices and household debt.

Canadian household debt

It’s also important to keep in mind that the most important thing for Canadian mortgage rates isn’t the Bank of Canada, it’s the Fed. The Canadian bond market – like much of the world – is rocked by the Fed. So if the Fed is forced to over-tighten to control its own economy, then even if the BOC cuts rates, it could still burst the Canadian housing bubble disastrously.

That said, has the market suddenly taken notice of this risk lately? Is this why the CAD failed to keep up with the astonishing rise in oil and other commodities? No, I don’t think that’s the case. It’s more about USD flow and trading risk.

But if we find ourselves in a situation where inflation starts to run high, there will be no help from the loonie coming from commodities.