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Canadian Dollar Forecast Remains Cloudy amid Declining Crude Oil Prices

Canadian Dollar Forecast Remains Cloudy amid Declining Crude Oil Prices

Christopher Vecchio, CFA, Senior Strategist

USD/CAD Rate Forecast Overview:

  • USD/CAD rates have gained nearly 1.6% in January while CAD/JPY rates have dropped by 1.2% amid growing concerns that the Chinese coronavirus will derail global trade.
  • Bank of Canada interest rate cut expectations continue to rise in the wake of the January BOC meeting. Immediately after, markets were pricing in July 2020 for the first rate cut; now, rates markets foresee the first cut in April 2020 and a second cut in December 2020.
  • According to the IG Client Sentiment Index, USD/CAD rates have a bullish trading bias.

Canadian Dollar Continues to Slide

The Canadian Dollar’s rough January continues. After a promising start to the year amid a surge in crude oil prices, the acute de-escalation in US-Iranian tensions provoked a dramatic plunge across energy markets. With the Chinese coronavirus on the march (transmissibility appears to be at pandemic levels), traders are suddenly reaching for safe havens and dumping any growth-related currencies and commodities. USD/CAD rates are up by 1.58% month-to-date while CAD/JPY rates have lost -1.20%.

BOC Rate Cut Odds Continue to Rise

In the week following the January Bank of Canada rate decision, the Canadian Dollar has continued to struggle alongside other commodity currencies amid rising global concerns. The spread of the Chinese coronavirus has sent growth-related commodities tumbling throughout January, underscoring the BOC’s concern that the recent slowdown in Canadian economic data may not be due to temporary but rather global factors.

Bank of Canada Interest Rate Expectations (January 27, 2020) (Table 1)

Canadian Dollar Forecast Remains Cloudy amid Declining Crude Oil Prices

According to Canada overnight index swaps, rates markets are now pricing in an implied probability of 67% for the a 25-bps rate cut to come at the April BOC meeting – three months earlier than previously anticipated. Similarly, there is now a 53% chance that a second 25-bps rate cut comes at the December BOC meeting. At the start of 2020, rates markets did not have any interest rate cuts priced-in for 2020; the dramatic escalation in rate cut odds weighs heavy on the Canadian Dollar.

USD/CAD Rate Technical Analysis: Daily Chart (January 2019 to January 2020) (Chart 1)

Canadian Dollar Forecast Remains Cloudy amid Declining Crude Oil Prices

USD/CAD rates continue to climb amid sluggish performances across energy markets; approximately 11% of Canadian GDP is tied to the oil sector. USD/CAD rates have reached their highest level since mid-December, and continue to make their way back towards the rising trendline dating back to the 2012 low. In the last update it was noted that, “the outside engulfing bar today, suggesting further gains in the days ahead.” It still holds that USD/CAD rates likely have a near-term bullish bias as a reversal within the congestion dating back to July continues; a full-scale reversal within the sideways range would likely see USD/CAD rates to climb back towards the mid-1.3300s over the coming sessions.

USD/CAD Rate Technical Analysis: Weekly Chart (September 2012 to January 2020) (Chart 2)

Canadian Dollar Forecast Remains Cloudy amid Declining Crude Oil Prices

The longer-term bias remains in place as USD/CAD rates work through key technical consolidations. “USD/CAD rates recently rebounded from the 61.8% retracement of the 2016 high to 2018 low range at 1.3065. While the return to the consolidation in place since July suggests a reversal towards 1.3350 is possible, traders may want to curb their enthusiasm for the time being: USD/CAD remains below the rising trendline dating back to the 2012 low.

“This trendline comes into play closer towards 1.3225 through the rest of this week; failure here would signify that USD/CAD’s longer-term topping efforts may still be valid. To this end, however, if USD/CAD rates are able to clear 1.3225, we would begin to consider price action in recent months a “false breakout” scenario,” ultimately calling for not only a return to 1.3350, but possibly the beginning stages of a longer-term march higher towards the 2016 high at 1.4690.

IG Client Sentiment Index: USD/CAD Rate Forecast (January 27, 2020) (Chart 3)

Canadian Dollar Forecast Remains Cloudy amid Declining Crude Oil Prices

USD/CAD: Retail trader data shows 40.26% of traders are net-long with the ratio of traders short to long at 1.48 to 1. The number of traders net-long is 1.06% lower than yesterday and 41.94% lower from last week, while the number of traders net-short is 13.93% higher than yesterday and 9.45% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests USD/CAD 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 USD/CAD-bullish contrarian trading bias.

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

Follow him on Twitter at @CVecchioFX

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

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