April BoC: On Hold, But Nerves Might Be Showing

The Bank of Canada (BoC) held the overnight rate at 4.50% in the April policy decision, matching the (unanimous) market consensus and market pricing that assigned a very low probability to any change in rates. However, there were a few surprising elements to both the policy statement and Monetary Policy Report (MPR), including an upbeat forecast for 2023 gross domestic product (GDP) growth and a tweak to the Bank's forward guidance that removed the explicit reference to the conditional hold from January.

Headwinds from the U.S. financial sector were the most prominent driver of forecast revisions in the April MPR, with real GDP growth in the U.S slashed to just 0.4% in 2024 from 1.1% in January. This contrasted with more modest revisions to Europe (0.5% from 0.9%) and global GDP growth (2.1% from 2.4%), with weaker foreign demand underpinning a 0.5pp downgrade in Canada. However, the Canadian economy will enter 2024 on a stronger footing after a 0.4pp upgrade to 2023 GDP growth, with Q1 GDP tracking nearly 2pp stronger than in January, and the MPR omitted its previous note that a couple quarters of slightly negative growth were just as likely as a couple quarters with slightly positive growth. Government spending was also flagged as a factor for the upward revision.

Inflation revisions were far more subdued, with no change to the annual average in 2024 and only a 0.1pp downgrade to 2023. The Bank noted that inflation has continued to moderate as expected and flagged recent improvements on a 3m annualized basis but repeated that more progress is required to bring inflation all the way back to 2%. The Bank also expressed some concern that inflation expectations are not receding quickly enough, even with the progress in the Q1 Survey of Consumer Expectations.

Looking forward, the announcement sets up some potentially interesting meetings in Q3. The admission that getting all the way back to 2% inflation "could prove to be more difficult" is on some level a fairly obvious statement of fact, but it was nonetheless striking to see the BoC let its mask drop on the matter (their sole goal here is 2% inflation). Market context may be playing a role, as markets have priced in a pretty firm easing bias for the BoC, and we imagine the Governing Council sees that pricing as unwarranted. The perceived mispricing in the market might be the motivating factor behind the hawkish nuances in the statement.

In the near-term though, nothing changes. The Bank is playing wait-and-see. Governor Macklem noted in February that wage growth between 4% and 5% was not consistent with the inflation target. If it was true then, it should be true now. We still look for the Bank to remain at 4.50% for all of 2023, as we do expect growth to slow markedly in Q2. That said, if the expected softening in the labour market does not emerge, the BoC may have little choice but to tighten again. With markets likely to give the BoC a pass in June, we see more risk for rate hikes in the July and September meetings.

Rates: As mentioned above, the BoC's hold was truly expected and priced as near certainty. As we move forward, the data will need to shift soon to really rule out hikes. We emphasize our long-end focus where we see the best risk/reward in bull flatteners. We continue to emphasize conviction in the net supply story in GoC longs, and note May 1, June 1 and June 15 extensions coming up. Additionally, there is no 30y auction in May, adding to the supply-demand imbalance. In the front-end we are of the view that cuts will come in Q1'24 which guides our view on value in this segment of the curve.

FX: There’s isn’t much for CAD to latch on regarding the BoC announcement. The tone of the statement underscores more of a hawkish hold scenario, which has likely helped USDCAD nudge lower. USDCAD HFFV sits below 1.34, suggesting that the pair is trading rich to macro drivers. We continue to like 1.33/1.37 range and look to fade the extremes of that range. However, keep in mind that CAD isn’t really taking part in the broader USD downturn, implying once again that CAD could lag others on broader USD downturns, especially as the growth rotation has shifted to Asia. That should lend support to AUDCAD.