Diverging interest rates weakened currencies against the U.S. dollar
Fifty or 25 basis points; was it really a question, heading into this latest rate decision by the Bank of Canada (BoC)? We would say a 50-basis-point (half of a percentage point) cut to the overnight rate was not only necessary but also the most likely outcome. The Canadian economy has been growing at a lacklustre pace for some time now. Inflation is no longer a problem; on the contrary, disinflation may become more of a concern in the near term. Also, unemployment has been trending in the wrong direction for over a year. Given these conditions, the BoC’s mandate should be to return the overnight rate to its neutral position as soon as possible. The tone of its press release reflected this sentiment, particularly when it mentioned weaker business investment, inventories and exports, which are key drivers of growth.
Across the border, U.S. interest rate-cut expectations faced a reset. Markets are still pricing in a high likelihood of a cut next week (with 95% odds), but the outlook for 2025 has shifted drastically. Back in September, markets had priced in six rate cuts for the year. Now, only two 25-basis-point (quarter of a percentage point) reductions are expected, leading to a repricing of the U.S. dollar. As rate-cut bets faded, the greenback gained all week long, while the euro slipped to its lowest level since December 2022. The Canadian dollar was also hit hard, dropping to levels not seen since April 2020, exacerbated by ongoing tariff threats. In the bond market, U.S. yields climbed back near post-election highs, proving the shift in market sentiment. Even precious metals couldn’t escape the impact of the U.S. dollar’s strength, with gold starting the week well but dropping on Thursday and Friday.
Over in China, policymakers turned up the heat on monetary easing. President Xi Jinping’s Politburo announced a shift from the "prudent" policy that has been in place for 14 years, to a “moderately loose” monetary stance for 2025. This announcement marked a notable change in tone, with language around stimulus more direct than at any time in recent memory. However, investors met the move with cautious skepticism. Memories of September’s so-called "bazooka" fiscal package, which ultimately underwhelmed, remained fresh. While a looser monetary stance is seen as positive, many argue that it won’t be enough to materially alter China’s economic trajectory. Calls for a stronger fiscal push to accompany monetary easing are growing louder, with traders demanding action rather than promises.
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