US Dollar / Canadian Dollar Exchange Rate Forecast

Our overall outlook for the pair remains highly constructive, with the market in the process of carving out a major long-term base. Look for a fresh higher low now by parity, with plenty of upside seen over the coming weeks and months back towards the 1.2000 area. For now, initial medium-term resistance comes in by 1.1000, and a break above will be required to accelerate. Any setbacks should continue to be very well supported ahead of 1.0000.

The Canadian Dollar continues appreciating strongly against its US namesake on similarly strong rallies in oil prices, while fast-rising Bank of Canada rate forecasts have likewise boosted the Loonie’s stance through recent trade. Overnight Index Swaps predict that the Bank of Canada will be considerably more aggressive in tightening monetary policy through the coming 12 months. Elevated Consumer Price Index inflation numbers and truly impressive Canadian Employment figures quite easily build the case for a hawkish BoC.

Interest rates support further USDCAD weakness through the foreseeable future. Yet another major driver of the USDCAD has likewise shown substantial influence through recent trade; its correlation to crude oil prices remains near record-highs. In sum: interest rate expectations may be important on a more medium-term basis, but shorter-term moves will almost certainly depend on the trajectory of oil prices.

The Canadian Dollar’s performance against its US counterpart has been second only to the Japanese Yen since the beginning of the year, sending the USDCAD exchange rate deep into undervalued territory relative to the PPP-implied level. It seems that this mispricing is likely to get worse before it gets better in the near term as traders continue to bet on rate hikes Bank of Canada despite a clearly cautious policy statement following the first increase in borrowing costs. Indeed, a Credit Suisse gauge of priced-in monetary policy expectations shows the markets see a 100 percent probability of another 25bps increase in July and 114bps in tightening over the next 12 months. Only a renewed flare-up of risk aversion seems like a reasonable catalyst for bullish momentum. Indeed, with China proactively moving to slow its economy amid fears of asset bubbles and runaway inflation and the EU hamstrung, the US is left as the sole major driver of global economic recovery; if the States are unable to shoulder this burden and the rebound falters, renewed flight toward safe-haven assets promises to send the US Dollar higher, particularly against the risk-sensitive commodity currencies. On balance, we will opt to allow the situation to play out over the weeks ahead and look for long entry opportunities, ideally as current undervalued conditions become more extreme.

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.