CAD, WTI Analysis: CAD/JPY coils at cycle highs ahead of BOC meeting

Monetary policy divergences and increased appetite for risk are key drivers for CAD/JPY

Correlations are far from perfect, but they can complement trends amongst markets over the longer-term and help explain the underlying dynamics of a move. Taking CAD/JPY as an example, oil prices can be a key driver of the Canadian dollar as it is a key export for the Canadian economy. Appetite for risk can also support commodity currencies such as CAD and global indices, whilst seeing an outflow from the yen (a safe haven) to support pairs such as CAD/JPY. Of course, monetary policy is also a key factor for respective economies, and the fact that economic data supports higher rates for the BOC (Bank of Canada) whilst the BOJ (Bank of Japan) stick to their ultra-dovish guns helps to explain why CAD/JPY has produced a very strong rally of late.

Incidentally, the weaker yen has helped to propel the Nikkei 225 to a three-decade. Global stock markets have also seen increased support in recent weeks as they became more confident that many central banks were at (or very near) the terminal rate of their tightening cycles. Yet an improvement of Canadian data (and a 25bp hike from the RBA) also saw further demand for CAD as it slightly increases the odds that the BOC may be forced to hike further.

Interestingly, the correlation between oil and CAD has broken down lately, with TWI trading closer to its 2023 low relative to its 2023 high. In turn this suggests divergent monetary policy and an improved appetite for risk have been the key drivers for CAD/JPY’s rally, and it would likely be trading even higher if there was a stronger bullish case for oil prices.

Will the BOC hike or pause today?

There was a little excitement generate for CAD bulls when the RBA hiked rates by 25bp yesterday, but if we look over some key data points form the last month I suspect the BOC still have room to hold. For now, at least. Employment remains tight, although job growth was propped up by part-time jobs whilst full-time jobs contracted in April. Unemployment and participation rate remain steady at 5% and 65.6% respectively. PMI’s have slowed, inflation metrics are trending lower whilst producer prices, retail sales and the housing sector are also cooling. GDP exceeded expectations and business confidence has continued to improve.

Whilst I personally favour a hold, it is possible we’ll see a slightly hawkish tone included in an attempt to keep inflation expectations under control, but if April’s statement is anything to go by it will be mostly balanced.