cad fundamentals

US Dollar - Canadian Dollar Exchange Rate Forecast

Tuesday, 03 February 2009 18:46:44 GMT  |  Jamie Saettele, Senior Currency Strategist; David Rodriguez, Quantitative Analyst; Ilya Spivak, Currency Analyst

US Dollar - Canadian Dollar Monthly Technical Forecast

The multi-year count treats the decline from 1.6194 as a correction (zigzag), indicating that the USDCAD should exceed that level eventually. In the month ahead, the USDCAD most likely rallies through 1.3025 in order to complete 5 waves from .9055. 1.40 is a bullish target going forward. Staying above 1.1459 keeps this forecast on track.

US Dollar - Canadian Dollar Interest Rate Forecast

Relatively small shifts in US Dollar and Canadian Dollar interest rate differentials have had little impact on the USD/CAD exchange rate, and we expect this will continue to be the case through the foreseeable future. The US Dollar currently carries its lowest short-term interest rate through modern records, and Canadian dollar yields are in a similarly depressed state. Other factors such as commodity prices and broader US Dollar trends have subsequently had far more substantial impact on the USD/CAD pair.

Interest rate traders and analysts predict that the Canadian dollar will lose a further 89 basis points in yield through February, 2010, and the US dollar will add a marginal 51bp through the same period. Said shifts would leave the USD/CAD rate differential at a virtually non-existent 0.14 percent. In a yield-sensitive environment, these forecasts would produce a fairly bearish bias for the Canadian dollar (bullish for USD/CAD). Yet we believe that commodity prices will likely be the major driver of USD/CAD price action through the medium and longer term.

US Dollar - Canadian Dollar Valuation Forecast

We noted last month that although "the Canadian Dollar is effectively at purchasing power parity…a period of undervaluation may be next as interest rate expectations point to substantial rate cuts from the Bank of Canada." Indeed, USDCAD now stands above its implied exchange rate. Though expectations of monetary easing have been close to halved, the currency's strong performance through January (second only to the Yen) are likely to see another test of 1.30 before the tide turns to favor the bears. 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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