USD/CAD extends gains beyond 1.3850 as markets turn cautious
- The US Dollar rallies for the third consecutive day, reaching levels right above 1.3850.
- A cautious market mood amid ongoing geopolitical risks is underpinning demand for the safe-haven USD.
- BoC Governor Tiff Macklem warned about systemic risks to the Canadian economy.
The US Dollar rallies for the third consecutive day against its Canadian counterpart, hitting its highest price in nearly two weeks at levels beyond 1.3850. In the absence of key data, investors’ caution amid ongoing geopolitical risks is giving the safe-haven USD a competitive advantage on Wednesday.
On Tuesday, Fed Chairman Jerome Powell highlighted the challenges ahead for the Fed to support a softening labor market without boosting inflation and warned that further interest rate cuts are not guaranteed.
The market anticipates further easing by the Fed and the BoC
The market, however, paid little attention to those comments. Futures markets keep pricing more than 90% chances that the US central bank will cut rates by a quarter point in November, and almost 80% chances of another 25 bps cut in December.
On the macroeconomic front, business activity data supported that view. The US preliminary Manufacturing PMI eased to 52 in September from 53 in August, while the services sector’s activity eased to 53.9 from 54.5 in the previous month. Both readings fell in line with the market expectations and, therefore, the impact on the US Dollar was moderate.
In Canada, BoC Governor, Tiff Macklem, warned about further systemic risks to the economy amid shifts in global trade and financial flows and the weakening US Dollar. The Bank of Canada cut rates to a three-year low of 2.5% last week, and the market is anticipating further cuts this year, following the track of the Fed. This is keeping the Canadian Dollar’s upside attempts limited.
Central banks FAQs
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.
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