cad fundamentals

US Dollar/Canadian Dollar Exchange Rate Forecast

Monday, 22 December 2008 20:12:33 GMT  |  Jamie Saettele, Senior Strategist; David Rodriguez, Quantitative Analyst; Ilya Spivak, Currency Analyst

US Dollar/Canadian Dollar Long-Term Exchange Rate Technical Forecast

The multi-year count treats the decline from 1.6194 as a correction (zigzag), indicating that the US Dollar/Canadian Dollar should exceed that level eventually. In the month ahead, the US Dollar/Canadian Dollar most likely rallies through 1.3025 in order to complete 5 waves from .9055. It is unclear whether or not the advance occurs with 1.1459 remaining intact. 1.40 is a bullish target going forward. A deep retracement of the rally from .9055 is expected once 5 waves are complete.

US Dollar/Canadian Dollar Exchange Rate Interest Rate Forecast

The Canadian dollar rallied sharply against the US Dollar through recent trade, as the US Federal Reserve's aggressive interest rate cuts left the Canadian currency at a clear advantage against its US namesake. The Canadian Dollar currently enjoys a 1.25 percent yield advantage against the Greenback-a fact that has bolstered demand in the otherwise-downtrodden Loonie. In terms of expectations, however, traders predict that the Canadian currency will lose the vast majority of this yield advantage through 2009.

Combined with a bearish outlook for Canadian exports, negative Bank of Canada rate expectations leave a pessimistic fundamental bias for the Canadian Dollar. Oil prices near multi-year lows have likewise played a part in Loonie weakness, and few envision that major commodity markets will improve substantially through 2009. As the most export-dependent economy in the G10, Canada may be one of the countries most affected by a drop in global consumption. This leaves the Canadian dollar in a precarious position, and outlook remains bearish for the Loonie through the foreseeable future.

US Dollar/Canadian Dollar Exchange Rate Valuation Forecast

US Dollar/Canadian Dollar Valuation Forecast: Bullish

As we noted last month, "The Canadian Dollar is effectively at purchasing power parity against the US dollar having declined sharply since late September." Looking ahead, a period of undervaluation may be next as interest rate expectations point to substantial rate cuts from the Bank of Canada. The CAD has also underperformed most other major currencies in December, with only the Pound seeing a worse result against the greenback. From a valuation standpoint, traders may want to exploit more attractive extremes elsewhere rather than bet on how far USDCAD may deviate and for how long.

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 the Organization for Economic Cooperation and Development (OECD). We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar. Currencies overvalued against the Dollar are denoted in RED, while those that are undervalued are denoted in GREEN.

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