Just a week after jilting the CAD with a dovish interest rate statement, Governor Poloz is turning hawkish once more - and is outright bullish on the economy.

Delivering a speech titled Three Things Keeping Me Awake at Night, Poloz told an audience at the Canadian Club in Toronto there is much to be pleased about when looking back on 2017 and that the outlook for the year ahead is promising.

“The economy has made tremendous progress over the past year, and it is close to reaching its full potential. We are very encouraged by this, and we are growing increasingly confident that the economy will need less monetary stimulus over time,” the governor said.

His comments sparked a rally in the Canadian Dollar and a rise in Canadian bond yields that continued into the Friday session.

“The comments have increased the likelihood of another BoC rate hike early next year although a spring hike still appears more likely. An outcome which appears relatively well priced at the current juncture, and as such should offer only modest support for the loonie in the near-term,” says Lee Hardman, a currency analyst at MUFG.

The Pound-to-Canadian Dollar rate was Canadian Dollar rate was quoted 0.54% lower at 1.7095 while the USD/CAD rate was 0.20% lower at 1.2768.

Above: Pound-to-Canadian-Dollar rate shown at hourly intervals.

The Bank of Canada raised its cash rate twice between the beginning of July and end of September, adding a total of 50 basis points, which has taken it to 1%.Markets had been betting as recently as October, on another rate hike coming in December or January.

However, a run of poor economic data and a string of bearish comments from Governor Poloz put paid to these notions over the course of November. This triggered a steep sell-off for the Canadian Dollar that endured well into December. Some say it could still have further to go.

“Recent CAD selling by hedge funds and real money represents an important directional shift. Hedge funds have moved decisively to reduce extended CAD longs; real money are lagging and have much further to go,” says Ben Randol, a strategist at Bank of America Merrill Lynch.

“We continue to think that USDCAD will retest 1.33, driven by fundamentals and position liquidation potential.”

Above: USD/CAD rate shown at hourly intervals.

Overnight Index Swaps prices currently imply a Canadian cash rate of 1.25% in April 2018, suggesting a firm bet by the market that the BoC will have added 25 basis points to its interest rate by then.

September 2018’s OIS rates imply a cash rate of 1.48%, again implying a firm bet by the market that the BoC will have raised interest rates again by that time.

“Overall his remarks regarding the need to remove stimulus temporarily revived market expectations, sending the 2Y yield 6bp higher and USDCAD lower by nearly a percent,” says Fred Demers, chief Canada macro strategist at TD Securities.

“But like a good economist, Poloz [Captain Hawk] kept a balancing act by also arguing the economy was approaching its sweet spot where demand creates its own supply.”

Translated into layman's terms, Poloz has told markets the Canadian economy is approaching a point where robust levels of demand will be able to continue without generating too much upward pressure on inflation.

This would enable the Bank of Canada to be more patient when it comes to another interest rate hike and so should, in theory, be bad for the currency.

“Since we'll only October GDP in hand by the time the Bank meets in January, it will take a truly blowout result to push the Bank into a hike at the beginning of the year. Since there's [no] evidence to suggest that yet, we're keeping our April call for now, although risks have skewed toward an earlier move,” says Nick Exarhos, an economist at CIBC Capital Markets.

OIS and currency markets clearly disagree with Poloz assessment, and so too do economists and strategists, many of whom predict another increase in Canadian interest rates by April next year.

"Despite the things that keep him awake at night, Poloz is now “increasingly confident” that less stimulus is required over time. We think this reference is an attempt to keep the market warm in pricing an equal chance of hike/hold at the January decision. Against this backdrop, we expect USDCAD to remain trapped within well-established ranges," says TD's Demers.

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