USD/CAD

A month long rally for the Canadian dollar has come to an end with the com-dollar giving back nearly 200 pips to the greenback over the past three trading days. Rising commodity prices and yield expectations had fueled the rally which saw a cautious BoC and concerns over Chinese demand reverse sentiment. A robust China GDP report stokes fears that the PBOC will step up their efforts to cool their overheating economy. Commodity prices are getting battered on the prospect of lower demand from the Asian giant with oil slipping over 2.5% on the day. Crude remains the primary driver of price action for the USD/CAD accounting for 637% of volatility. However, we have seen its influence weakened from 73% a month ago as yield expectations grew in importance from 13% to 18%. The potential for tightening may remain a supportive factor for the pair as markets continue to price in multiple hikes over the next year from the Canadian central bank. Parity has slowed gains and failure to hold above increases downside risks as the psychological level has turned into resistance.

Driver of Price Action

Current Influence

Correlation

Week Ago

Month Ago

CAD Interest Rate Expectations

Low

-0.18

-0.18

-0.13

USD Interest Rate Expectations

Low

-0.25

-0.24

-0.18

Oil

High

-0.67

-0.68

-0.73

Canadian_Dollar_Follows_Crude_Lower_on_Chinese_Tightening_Fears_body_Picture_1.png, Canadian Dollar Follows Crude Lower on Chinese Tightening Fears

BoC Interest Rate Expectations

Markets continue to price in multiple rate hikes from the BoC with Overnight Index Swaps calling for 82 bps in tightening over the next year. Upside surprises in the leading indicator reading and wholesale sales have helped offset the dovish tone to the central bank’s post policy meeting statements. The Monetary authority expressed concerns over the impact of the “loonie’s” strength on export demand and as a result future interest rate rises will be “carefully considered”. Despite, policy maker’s concerns they raised their growth forecasts for both 2011 and 2012 and expect inflation to reach target levels by the end of 2012. Therefore, it may be a matter of time before we see further tightening, which could remain a supportive factor for the com-dollar. Discuss this and trading ideas join the USD/CAD forum.

Credit Suisse (OIS) BoC

Canadian_Dollar_Follows_Crude_Lower_on_Chinese_Tightening_Fears_body_Picture_2.png, Canadian Dollar Follows Crude Lower on Chinese Tightening Fears

Source Bloomberg – Prepared by John Rivera

FOMC Interest Rate Expectations

Fed fund futures are now pricing in a mere 2.6% chance of a rate hike by June as yield expectations continue to dim with the U.S. recovery expected to be slow. However, a significant drop in initial jobless claims and 12.3% jump in existing home sales are signs that the labor and housing markets are making positive strides. Markets will need to see further confirmation before the outlook for interest rates brighten, but it could bring an end to prevailing pessimism. There will most likely be little change in the outlook for yields with the FOMC rate decision ahead on January 26th, which could allow for short-term greenback support.

Canadian_Dollar_Follows_Crude_Lower_on_Chinese_Tightening_Fears_body_Picture_3.png, Canadian Dollar Follows Crude Lower on Chinese Tightening Fears

Source Bloomberg – Prepared by John Rivera

Oil

Crude prices stumbled on the prospect that Chinese tightening will curb global demand, falling nearly $3 before regaining its footing. We could see further weakness on fears that current prices are starting to stunt growth and may lead to a reduction in consumption. Crude above $80 per barrel is considered damaging to global growth, with ideal levels at $70 to $80. However, OPEC is comfortable with prices between $80 and $100 per barrel before they start to consider changing quotas. The prospect of an increase in production could limit further upside potential with $93.00 providing resistance. A second failed test of the psychological level increases risks of a decline to its rising trend line at $87.50 per barrel, potentially providing additional USD/CAD support. However, an ultimate test of $100 per barrel can’t be ruled out before we see a more significant reversal. Discuss this and other fundamental data in the Economics Forum.

Oil (1 Day)

Canadian_Dollar_Follows_Crude_Lower_on_Chinese_Tightening_Fears_body_Picture_4.png, Canadian Dollar Follows Crude Lower on Chinese Tightening Fears

Charts created using Strategy Trader– Prepared by John Rivera

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com