USDCAD bulls holding more of the cards
- Canadian data undermines loonie
- Yellen's comments fuel US dollar demand
- Loonie vulnerable to further weakness
By Michael O'Neill
USDCAD has decisively broken above the middle (1.2900) of its 1.2650-1.3250 range that has been intact since May. Janet Yellen’s nod toward a US rate increase, last Friday, has sparked broad US dollar buying across the G10 spectrum and USDCAD has joined the party. Should you?
Reasons to buy USDCAD
1. US rate outlook: FX markets are beginning to believe that a US rate hike is possible as early as September 21, in part because of Federal Reserve chair Janet Yellen’s comments on August 26, stating that she believes the case for a rate increase has strengthened.
2. Oil prices: The supply demand imbalance does not appear to have been corrected. Saudi Arabia and Iran have increased production although demand has not increased. The CEO of Shell told Reuters that he didn’t see the oil market rebalancing until the end of 2017. Renewed WTI weakness would lead to USDCAD gains
3. Seasonal issues: USDCAD tends to strengthen between September and December. Since 2010, USDCAD has strengthened four out of five times. Part of the move can be attributed to repatriation flows. A large number of Canadian corporations are US-owned and profits get returned to the parent at year-end.
4. Bullish long term technicals. USDCAD has been in an uptrend since bottoming out at 1.0620 in June 2014 and that uptrend line comes into play at 1.2730. In addition, Fibonacci retracement of the 2016 range projects a move to 1.3570 on a break of 1.3308.
USDCAD seasonal strength
Reasons to sell USDCAD
1. Q3 Economic rebound: The Bank of Canada (BoC) forecast in the July Monetary Policy Report (MPR) that Q3 GDP growth would be 3.5%. This growth will be driven in part by Federal Infrastructure spending and non-commodity exports. Non-commodity exports are close to pre-recession peaks and are expected to grow in line with the US economy.
2.Rebounding US economy: The latest Atlanta Fed’s GDPNow forecast is 3.5%, as of August 29. The US is Canada’s largest trading partner and Canada and the Canadian dollar does well when the US economy expands.
3. Oil prices are firm: WTI is in an intraday uptrend while trading above $46.25. If the uptrend remains intact, USDCAD gains should be limited. Oil prices are torn between speculation of a price support mechanism being adopted by Opec in Algiers on September 27 and reports of increasing supply amid stagnant demand.
4. A 0.25% US rate increase is not a surprise. The Federal Open Market Committee has been priming the pump for a rate increase since last December. US rates are extremely low by historical standards so a bump in rates to 1/2 to 3/4 percent shouldn’t bother anyone.
None of the reasons to buy or sell USDCAD are new or fresh and should already be reflected in the price. These moves have occurred in a holiday-thin-market environment. It is the last week of the summer (ignoring the calendar) and a large number of traders are on vacation which suggests that FX moves may be exaggerated.
Canada posted a current account deficit of $19.86 billion which, while expected, will undermine the currency. Wednesday’s GDP data will be important. The Q2 data is expected to be weak but the June month over month data isn’t. If the Canadian economy is going to rebound in the second half, a healthy jump in the June numbers would be a big help.
It is telling that even after Yellen’s speech and supportive input from vice chair Stanley Fisher, the rate hike odds for September, as posted by CME FEDWatch Tool, are only 20%. Those odds may change on Friday with the release of the US nonfarm payrolls report.
Despite the diverse Canadian dollar influences, the Loonie remains at the mercy of two key drivers; oil prices and US interest rates. As long as the US interest rate outlook is bullish and oil prices remain soft, USDCAD will remain bid.