Wednesday's Bank of Canada decision isn't just for Canadian dollar traders. It's one that could herald a more-patient view from global central bankers in a surprise shift.
Economists largely expect the Bank of Canada to hike by 25 bps to 4.50% but it's far from certain. The rates market is pricing in a 31% chance the BOC leaves rates unchanged.
If they do that, they will become the first major central bank to shift to neutral and that may foreshadow what's to come from others, and sooner than anticipated.
In deliberating the decision, the Bank of Canada is likely struggling to make sense of recent economic data. Jobs numbers have been extraordinarily strong, including a gain of 104K in the December report compared to 8K expected. CPI fell 0.5% in December but that was short of the -0.6% consensus of economists and core prices have remained sticky, with the BOC's core measure up 0.3% m/m in December.
But jobs and inflation are lagging measures and more forward-looking indicators are showing some softness. The latest retail sales data was softer than anticipated and the BOC's Business Outlook Survey showed an a slowdown.
Also weighing is Canada's overheated housing market with prices down by more than 20% from the peak in much of the country and mortgage resets hitting consumers hard.
The BOC has offered little clear guidance on what it will do next. After hiking by 50 bps in December, the BOC statement said:
Looking ahead, Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target. Governing Council continues to assess how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding.
Central bankers globally have been encouraged by recent inflation dynamics and the BOC is likely no different however we haven't heard from anyone at the BOC since mid-December.
In any case, the BOC isn't afraid to go against the market consensus and has done so more than half the time in the past year, according to National Bank.
Does it make a difference?
The BOC is either going to pause now or hike 25 bps and then pause. Is that a big difference? No, I'd argue it's immaterial. There will likely be a +100 pip CAD fall if they pause and 30 pips if they hike but I wouldn't expect it to leave a lasting effect on domestic markets.
Where it could reverberate is in international markets. The BOC (along with the RBNZ) was the first to hike and by going to the sidelines first it could signal that other central bankers will soon do the same. Groupthink dominates 21st century central bank thinking and the market would be wise to recognize that a BOC shift won't be a solo move.
That would be a good sign for global risk assets and global growth.
However if they do pause, pay attention to the reasoning. If Macklem puts a strong emphasis on domestic risks like property markets, that's a factor that doesn't necessarily translate abroad. Highlighting the housing market may also cause the market to refocus on vulnerabilities in that sector.
Overall, it's a question of whether the BOC wants to cushion the coming pain or to squash out any hint of inflation. I believe they would be better served to let the Fed and other central banks do the last of the heavy lifting but it's a close call. On balance, that should support buying USD/CAD or AUD/CAD into the decision.