As soon as the U.S. Federal Reserve confirmed the widely-expected decision to keep its interest rates unchanged at 1.75%, economists began to estimate the outcome of the next Fed meetings. In general, they see the Fed going slow which would continue to boost the Canadian dollar.

TD Bank economists noted that the Fed’s decision and policy statement was virtually identical to the one it issued on April 19, 2002. “While acknowledging that the U.S. economy burst out of the starting gates in the opening quarter of 2002 on the back of a ‘marked swing’ in inventory investment, and recognizing that the current stance of monetary policy is ‘accommodative’, the Fed’s statement left little doubt as to where its attention is truly focussed namely, on the state of final demand.”

TD says, “There was nothing in today’s statement to steer us away from the view that the Fed will want to see a recovery in final demand staring it straight in the face before it starts to tighten its monetary settings. As a result, we still do not expect a rate hike before the August FOMC meeting although the Fed may shift to a tightening bias at the June 25-26 confab if the recovery’s underpinnings start to appear more firmly anchored in the weeks ahead.”

BMO Nesbitt Burns agrees that the Fed is clearly worried about demand, and is not concerned about near-term inflation risks or the recent decline in the U.S. dollar. “At this stage, it appears to be a safe bet that the Fed will remain on the sidelines until late June, or more probably, late August. This means that the Bank of Canada’s actions to step out in front of the Fed will continue to apply upward pressure to the Canadian dollar.”

BMO Nesbitt also says that indications point that the Bank will tighten again in June. “I expect the Canadian dollar to rise through next year as the TSE outperforms the S&P 500. The loonie could well hit 65-66 cents by the end of next year,” predicts BMO Nesbitt chief economist Sherry Cooper.

Over at Bank of Montreal, the feeling is that the Fed is expected to begin tightening at the August 13 policy meeting, assuming employment strengthens in coming months and business investment picks up. The federal funds rate is expected to rise 125 basis points in the second half of the year and an additional 250 basis points next year. “The risk however, is that the economy could be weaker and inflation lower than we anticipate, warranting less aggressive rate action.”

TD says that the Bank of Canada is poised to raise rates at each of its next two fixed announcement dates in June and July, pushing the gap between the two countries’ key policy rates out to 100 basis points. “This may not be good news for the bond market, but it will certainly be another tick in the plus column
for the Canadian dollar.”