Canadian Dollar Outlook Hinges On BoC Rate Decision

Fundamental Forecast for Canadian Dollar: Bearish

• USDCAD: Pullback Sought to Enter Long
• Canadian Dollar Reverses Sharply at Trendline
• Loonie Falls as November Employment Continues to Disappoint

The sharp rally in the Canadian dollar tapered off on Friday following the dismal employment report, and the loonie may further retrace the advance carried over from the previous month should the Bank of Canada strike a highly dovish outlook for monetary policy. The BoC is widely expected to keep the benchmark interest rate at 1.00% in December, but the policy statement could weigh on the exchange rate should the central bank continue to curb its fundamental assessment for the region.

As the BoC drops its pledge to withdraw monetary stimulus, we expect the central bank to maintain its wait-and-see over the coming months, but Governor Mark Carney may show an increased willingness to scale back the interest rate as policy makers expect the economy to operate below full-capacity until the end of 2013. Although the 3Q GDP print came out stronger-than-expected, the recent downturn in the labor market paired with the slowdown in price growth may lead the BoC to change up its tune as inflation is expected to fall below the 2% target next year. In turn, dovish comments from Governor Carney are likely to dampen the appeal of the loonie, and the USD/CAD looks poised to push higher in the following week as it appears to have carved out a higher low. As the pair maintains the upward trend from back in July, we should see the rebound from 1.0078 pick up next week, and the exchange rate may make another run at the 61.8% Fibonacci retracement from the 2007 low to the 2009 high around 0.9880-0.9900 as the BoC looks to shore up the real economy.

As the rate decision highlights the biggest event risk for the following week, market participants may turn a blind eye to the Ivey Purchasing Manager Index, and we may see the policy statement influence the Canadian dollar throughout December as market participants weigh the outlook for future policy. At the same time, the BoC’s Financial System Review may cast a bearish outlook for the Canadian dollar as the central bank warns of the record expansion in household debt, and we may see the USD/CAD carry the upward trend into the following year as the fundamental outlook for Canada deteriorates. - DS