Bank of Canada hits pause on rate hikes. Why traders think Fed will follow suit.

The Bank of Canada raised its benchmark interest rate by a quarter of a percentage point on Wednesday, as expected, but surprised traders as it signaled a willingness to hold off on further hikes if the economy cooperates.

The prospect of an end to a streak of aggressive interest rate hikes helped weaken the Canadian dollar against the US dollar. In an interesting twist, the US dollar, in turn, weakened against its major rivals, suggesting traders may be speculating that the Federal Reserve may follow suit after securing a quarter-point hike next week.

Wednesday’s rate hike was the eighth consecutive rate hike by the Bank of Canada.

“If overall economic developments develop in line with the MPR outlook, the Board intends to keep the policy rate at the current level while it assesses the impact of cumulative interest rate hikes,” the BOC said in a statement. BOC Governor Tiff Macklem stressed at a press conference that policymakers are looking for a “conditional pause.”

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Canadian dollar USDCAD,
+0.12%
weakened slightly against its U.S. counterpart, with the U.S. unit up 0.1% at C$1.3385 in recent trade, but traders noted that the U.S. dollar, in turn, had weakened against other rivals.

euro EURUSD,
+0.23%
Against the U.S. dollar, it rose 0.2% to $1.0914, while the U.S. currency fell 0.5% to 129.58 Japanese yen USDJPY,
-0.45%.
ICE US Dollar Index DXY,
-0.22%,
the currency index against a basket of six main competitors, fell by 0.2%.

“Interestingly, the exchange rate reaction shifted to the USD, which weakened as markets saw a greater risk of the Fed following the BOC with a dovish hike next week. This helped somewhat limit the jump in USD/CAD,” said James Knightley, chief international economist, and Francesco Pezol, FX Strategist at ING.

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Analysts said traders may see the Bank of Canada’s decision as a potential tipping point in an aggressive tightening cycle by most of the world’s major central banks.

“Investors are increasingly confident that more central banks will soon stop raising interest rates as there are more signs that global inflation is easing, although the outlook remains uncertain and there have been a few surprises here and there,” said market analyst Fawad Razaqzada. City Index and Forex.com note.

U.S. stocks pared sharp losses to trade slightly lower in afternoon trade, which was unchanged on Wednesday, with the Dow Jones Industrial Average DJIA,
-0.04%
was down about 10 points, or less than 0.1%, while the S&P 500 SPX,
-0.11%
decreased by 0.1%.

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Investors have highlighted the disconnect between financial markets and the rhetoric of Federal Reserve policymakers.

The Fed’s so-called dot chart forecast shows that policymakers expect the federal funds rate, currently at 4.25% to 4.5%, to peak above 5% and stay there, unlike federal funds futures, which are priced there will likely be cuts by the end of the year.

Fed-funds futures indicate traders expect the Fed to cut rates by the end of the year and a strong rebound in tech and other growth-related stocks this month, analysts said.

See: Tech rally is ‘biggest game of chicken between Fed and market I’ve ever seen’: analyst

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