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Bullish USD/CAD on Deteriorating CA Fundamentals and Dovish BoC

Bullish USD/CAD on Deteriorating CA Fundamentals and Dovish BoC

Tyler Yell, CMT, Currency Strategist

The BIG Idea: USDCAD took a trip to new highs on the year on Wednesday after the Bank of Canada dropped dovish comments that they see more room for non-inflationary growth and that the energy sector could be materially weaker than previously thought. At the same time, the US continues to show signs of overheating with the front-end of the US yield curve moving up aggressively relative to the belly and back-end this week that could see US Dollar strength continue.

  • Point to Establish Long Exposure: At market (C$1.3357 per USD)
  • Spot: C$1.3357 per USD
  • Target 1: C$1.3598 per USD (Minor Fibonacci expansion target,) > 1:1 Risk: Reward Ratio
  • Target 2: C$1.38206 per USD (Major Fibonacci confluence target,)1:5 Risk: Reward Ratio
  • Invalidation Level: C$1.3268 per USD (December opening range low,) 85 pip stop

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Bullish USD/CAD Trade Structure:

Bullish USD/CAD on Deteriorating CA Fundamentals and Dovish BoC

The Big Picture on Shorting the Canadian Dollar:

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Chart Source: Pro Real Time with IG UK Price Feed. Created by Tyler Yell, CMT

USD/CAD has broken to new highs, but that does not mean it is time to sell. Quite the contrary, the spread between the US Treasury 2yr yield and the CA 2Yr Treasury yield is near the widest in a year, and the Bank of Canada showed their remains capacity in the economy for growth before inflation pushes them to hike further.

A Widening US/CA Yield Spread Aligns With Weaker CAD

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Data source: Bloomberg

On Wednesday, the Loonie hit the lowest level of 2018. Why? The short answer is the central bank turned dovish after leaving interest rates unchanged, and in so doing they pared back optimism on the economic outlook.

Recently, I shared an article that showed the main Canadian Oil benchmark, Western Select Crude from Alberta had fallen alongside Canadian terms of trade throughout 2018.

Weakening Terms of Trade Highlights BoC's Materially Weaker Energy Sector Comment

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Data source: Bloomberg

The chart shows a drop from peak to trough in WCS Crude of 76.7% though it has rebounded on an announced production cut to stabilize the market. At the same time, Canada's Terms of Trade shows a marked breakdown though it recovered alongside WCS.

The question appears to be whether or not the damage is done or if the ripple effects will still be felt. If ripples will continue to flow through the CA economy, there could be a slowing of the Bank of Canada to lift rates as was earlier hoped.

When looking to rate expectations, traders can see that the pricing in of a 25bp rate hike from the Bank of Canada is falling. As it falls, so does the hopes of CAD bulls.

Rate Hike Bets by the Bank of Canada for early 2019 Tumble

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Data source: Bloomberg

The US Dollar continues to be the stronghold of Major Currencies. Among 16 currencies, all are down to the US Dollar year to date with the Japanese Yen the strongest relatively only down 0.45% with the Brazilian Real down -14.4%.

The Canadian Dollar is down -5.95% year to date with 0.6% coming on Wednesday, December 05 after the Bank of Canada turned dovish relative to expectations.

What is IG Client Sentiment Saying about the Canadian Dollar?

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Source: IG Client Sentiment

Retail trader data shows 16.3% of traders are net-long with the ratio of traders short to long at 5.15 to 1.

Traders have remained net-short since Oct 09 when USDCAD traded near 1.28092; the price has moved 4.5% higher since then. The number of traders net-long is 45.7% lower than yesterday and 49.8% lower from last week, while the number of traders net-short is 48.2% higher than yesterday and 23.4% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests USDCAD prices may continue to rise. Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger USDCAD-bullish contrarian trading bias(emphasis mine.)

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---Written by Tyler Yell, CMT

Tyler Yell is a Chartered Market Technician. Tyler provides Technical analysis that is powered by fundamental factors on key markets as well as trading educational resources. Read more of Tyler’s Technical reports via his bio page.

Communicate with Tyler and have your shout below by posting in the comments area. Feel free to include your market views as well.

Talk markets on twitter @ForexYell

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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