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USD/CAD Breakout Potential Persists as Crude Oil Breaks Down

USD/CAD Breakout Potential Persists as Crude Oil Breaks Down

Talking Points:

- Important week for US Dollar - FOMC could spark next leg higher.

- USD/CAD hasn't achieved C$1.3145 on a closing basis, yet.

- As market volatility stays elevated post-Brexit, it's a good time to review risk management principles.

Once again last week, USD/CAD failed to close through the key C$1.3145 level, despite the first test of levels above since the middle of May. For one, the market seems to be shaking off the surprising bout of Canadian economic data at the end of last week. Instead, there are two drivers in play right now: rising Fed rate expectations; and falling Crude Oil prices.

With Fed funds futures contracts implying June 2017 as the most likely period for the Fed's first rate hike, there has been a material shift forward from pricing pre-NFPs. Inherently, this has translated into broad support for the US Dollar. Concurrently, as the greenback has strengthened, assets priced in USD have fallen; precious metals (Gold, Silver) and energy (Crude Oil, Brent Crude) alike. Crude Oil itself is starting to establish a new trend of lower highs and lower lows, having just cleared out its mid-July swing lows (chart 1 below).

Chart 1: Crude Oil (CFD: USOIL) H4 Chart (May 8 to July 25, 2016)

As Crude Oil gathers pace below $44.40, its bearish momentum structure has solidified on the H4 timeframe. Price remains below its 8-, 21-, and 34-EMAs, while Slow Stochastics and MACD continue to trend lower in bearish territory. A move to the May 9 low of $43.03 over the coming sessions is increasingly possible. Accordingly, the recent breakdown in Crude Oil technicals fits neatly with the bullish technical structure of USD/CAD (chart 2 below).

Chart 2: USD/CAD Daily Chart (March to July 2016)

The case for a USD/CAD breakout through C$1.3145 remains valid, particularly as Crude Oil slips lower. The short-term bearish momentum structure in Crude Oil is matched by USD/CAD's more intermediate bullish technicals: price is above its 8-, 21-, 34-EMAs on the daily chart; and Slow Stochastics and MACD are trending higher in their respective bullish territories.

Chart 3: Inverse USD/CAD versus Price of Crude Oil (2015-2016)

True, the relationship between the Canadian Dollar and Crude Oil has weakened a bit in recent weeks (chart 3 above), but much of this has to do with the Brexit-related shock after June 24. Instead, with the 20-day correlation steadying above +0.60, we still believe there is strong evidence that what's bad for Crude Oil will ultimately be bad for the Canadian Dollar.

Read more: Pressure Back on EUR/USD as Market Sees Looser ECB, Tighter Fed

--- Written by Christopher Vecchio, Currency Strategist

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