Over the last few days, the Canadian dollar has been trading in a very tight range against the U.S. dollar. Yet, I expect a new wave of dollar strength going forward which could propel USD/CAD to test the 1.10 resistance level.
To some extent, the U.S. dollar remains vulnerable to a spike in energy prices. Yet, there are plenty of reasons to go long USD/CAD. First, a severe U.S. dollar undervaluation is now likely to lead to a substantial improvement of the U.S. Balance of Payments through continued strong export performance. Second, with the world economy slowing down is reasonable to think that the demand for commodities will also begin to slow down. As a result of this, commodity sensitive currencies like the Canadian dollar, Australian dollar and New Zealand dollar will be particularly vulnerable. Finally, a significant shift of interest rate expectations in favor of rate hikes by the Federal Reserve is likely to help the U.S. dollar to rally further.
The Canadian Economy is Slowing Down
The once immune Canadian economy has recently joined the list of economies that have been hit by the mortgage debacle. At the onset of the mortgage meltdown, the Canadian economy was faring well, with consumers remaining optimistic about the performance of the economy. Fast forward four to six months later, and the once resilient consumer confidence has been crumbling under the pressure of declining housing market and weak labor market. Moreover, businesses find it increasing difficult to remain optimistic on the back of tighter lending conditions and declining demand from domestic and global consumers alike, largely due to a strong currency.
Canadian Dollar Forecast
My recommendation is to buy USD/CAD at the market for 300 pips in profit potential with a stop in a daily close below 1.03. Indeed, higher interest rates could make the U.S. dollar more attractive to foreign investors and the higher level of demand for assets denominated in dollars could accelerate gains in the USD/CAD.
Written by: Antonio Sousa, Chief Strategist for DailyFX.com Questions? Comments? You can email Antonio at asousa@fxcm.com.