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The USDCAD rally has been impulsive, which suggests that 1.0200 is an important low that should hold for some time. The structure of the decline from 1.3068 is unclear (probably a complex correction as per labels) but a Fibonacci relationship also suggests that 1.0200 is an important low. The decline from 1.1730 would be equal to 61.8% of the 1.3068-1.0782 decline (on a pips basis) at 1.0203. The low also occurred in the confines of a large congestion area. Favor the upside with 1.1100 and 1.1400 as objectives.
The US Dollar/Canadian Dollar exchange rate has shown very little correlation to interest rate forecasts, and we have little reason to believe that said dynamic will change through the foreseeable future. Overnight index swaps currently predict that Bank of Canada and US Federal Reserve interest rates will be roughly equal in a year’s time. Barring any significant and/or unexpected shift, said predictions leave little interest rate bias for the USDCAD.
The exchange rate remains closely linked to global commodity prices, and the USDCAD-Crude Oil correlation trades near record-highs. It will subsequently be very important to monitor trends in raw materials prices, and a continued uptrend would bode well for the Canadian Dollar.
Although clearly trading rich against its US counterpart, the Canadian Dollar has not reached the kind of valuation extremes seen in some of the other major currencies, with prices now just over 11% away their PPP-implied exchange rate. On balance, the outlook for risky assets (and oil in particular) seems to be the key ingredient in shaping the pair’s trajectory gong forward, with any meaningful weakness in capital markets’ confidence likely to produce an upward correction. Threats of direct intervention to drive down the Loonie on the part of the BOC may help in this regard as well, especially considering that the central bank’s hand could be forced after a disappointing third-quarter GDP result.
What is Purchasing Power Parity?
One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.
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