Canadian Dollar Maintains Channel Formation, May Test 200-Day SMA

The Canadian dollar pared the decline from earlier in the week as the economic docket reinforced an improved outlook for the world’s eighth largest economy, but the rise in risk aversion may continue to weigh on the exchange rate as the greenback benefits from safe-haven flows. The USD/CAD rose to a fresh yearly high of 1.0782 and looks poised to test the 200-Day moving average at 1.0865 as the pair maintains the upward trending channel from the January low (1.0225), and we may see the dollar-loonie continue to retrace the decline from the previous year as the greenback loses its appeal as a funding-currency.

Indeed, we saw the Canadian labor market improve in January, with employment increasing 43.K from the previous month to top forecasts for a 15.0K rise, which pushed the jobless rate down to 8.3% from 8.5%. However, Bank of Canada Governor Mark Carney held a cautious tone during a speech earlier this week and said demands for employment “may grow relatively slowly” as businesses remain reluctant to expand their labor force, and reiterated that he expects inflation to hold below the 2% target until the third-quarter of 2011. At the same time, the central bank head said that businesses environment is starting the show “the first signs of a thaw in corporate attitudes,” and anticipates a rise in investment spending to support economic activity in the following year. As the BoC holds a dovish outlook for price growth, we are likely to see the central bank maintain its current policy as it aims to encourage a sustainable recovery, and interest rate expectations are likely to drive price action going forward as Mr. Carney looks to normalize policy this year.

Nevertheless, the fundamental releases scheduled for the following week are likely to boost the growth outlook in Canada, and we may see the USD/CAD hold a broad range throughout the month as investors weigh the prospects for a marked recovery. Housing starts are forecasted to increase at an annualized pace of 179.0K in January, which would be the highest reading since October 2008, while the trade deficit is expected to narrow to C$0.2B in December from C$0.3B in the previous month. However, as risk trends continue to dictate price action in the foreign exchange market, the rise in risk aversion may continue to drag on the Canadian dollar as traders move out of higher risk/reward investments. - DS