Source: The Canadian Press

The Canadian dollar could be in for some volatility this coming week as the Bank of Canada comes out with its latest announcement on interest rates Wednesday.

The dollar ended last week at the 96-cent mark and currency markets aren’t really sure which way the central bank will lean. That’s because analysts were putting the odds of another quarter-point hike – to 1% – at 50-50, reflecting a slowdown in the Canadian and particularly the U.S. economies over the last quarter.

“We are officially calling for the Bank of Canada to raise rates by a quarter point next week,” said Doug Porter, deputy chief economist at BMO Capital Markets.

“But I would say an informal poll of the economics department here would probably put the odds of that at about 55% to 60%. We do see it as a very close call and that’s the way the market is pricing for a rate hike right now.”

Meanwhile, stock markets could find momentum going into trading this week as readings last week on U.S. manufacturing and employment data could counter seasonal effects which have given September the reputation of the worst trading month of the year.

The Bank of Canada has raised rates from an historic low of 0.25% twice this year, in June and July, as the Canadian economy mended from recession faster than just about any other country.

But even with another quarter-point rise, the central bank could well decide to take a pause after recent data showed North American economies slowing.

The U.S. economy grew at an annualized rate of only 1.6% during the second quarter.

And Statistics Canada reported last week that the domestic economy grew at annualized reading of two per cent during the second quarter, down sharply from 5.8% in the January-March period.

Back in April, when things looked rosier for the global economy, Porter thought “the bank would raise its rates to about two and a half to three per cent over the next year. Now we’re thinking one to maybe 1.5%.”

And even before the central bank gets to that point, the question is how long it will keep rates at 1%.

“We now see that possibly right through the middle of next year and that’s really the big change in recent months for us – beyond just taking a little bit of a trip to the sidelines later this year, we think that could last longer,” Porter said.

“Because frankly it doesn’t look like the U.S. Federal Reserve is going to raise rates for at least the next year, and could drag well into 2012 even, unless we really get a very pleasant surprise from the U.S. economy.”

However, the revised forecast is certainly good news for consumer borrowing costs and could breathe new life into a flagging housing market.

“We have seen the longer-term mortgage rates coming down in recent months as that expectation of a less aggressive Bank of Canada has been built into the market,” Porter noted.

But no matter what the bank announces on Wednesday, Porter thinks there will be an effect on the loonie, particularly from the bank’s commentary.

“Let’s say they hike, and they come out and signal they might move to the sidelines, then the rally on the dollar won’t last long,” he said.
“If they hike and they still sound like they could hike further, then the currency will strengthen quite a bit. That’s not even getting into what it would do if they don’t hike.”

Meanwhile, stock markets ended the week on a strong note as positive manufacturing data from China and the U.S. and the U.S. employment report for August, which showed private-sector job creation exceeding expectations, left the TSX at a three-and-a-half month high.

The biggest headwind might just be the fact that it is September – the worst trading month of the year.

There are a few theories why this is so. For example, mutual fund managers take profits on winning stocks and ditch the losers as they make the third quarter look as good as possible.

Last year was a happy exception, as markets were in the course of a long positive run from the depths of March 2009 as investors started to price in a strong economic rebound.

The S&P 500 has shed at least 5% in September four times in the past decade alone.

However, this September could also prove to be a decent month.

“And that could be based on valuation that we’re seeing in the marketplace, it could be based on the fact that investors will be focusing on the positives as opposed to the negatives,” said Philip Petursson, director of institutional equities at MFC Global Investment Management.

“You have to focus on the fact that companies seem to be tripping over themselves to acquire each other. They are more confident and, from what we are seeing, there is much better investment opportunity in equities now than there has been over the past couple of years based on valuation, companies’ balance sheets (and) pending activity through merger and acquisition activity.”

Petursson added that another reason to be more optimistic on the equity markets is that, relative to bonds, stocks are cheaper than they have ever been.