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USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

2011-07-07 00:11:00
Joel Kruger, David Rodriguez, Ilya Spivak,
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US Dollar / Canadian Dollar Technical Forecast

Weekly Chart

USDCAD_US_Dollar_Canadian_Dollar_Exchange_Rate_Forecast_body_EURJULY.png, USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

Prepared by Joel Kruger

The market remains confined to a very well defined downtrend off of the 2010 highs and will need to break back above 0.9900 at a minimum to force a shift in the overall structure. However, we are seeing some shorter-term signs of a potential base by 0.9450, and look for any additional weakness from here to be very well supported on dips ahead of 0.9500. Look for a break back above 0.9700 to confirm and accelerate. Only below 0.9500 concerns.

US Dollar / Canadian Dollar Interest Rate Forecast

Currency, Central Bank

US Dollar, US Federal Reserve

Canadian Dollar, Bank of Canada

Net USDCAD Spread

Signal

1-Year Expectations(Basis Points)

16

58

(42)

Bearish

Yield in 1 Year(Percent)

0.41

1.58

(1.17)

Bearish

USDCAD_US_Dollar_Canadian_Dollar_Exchange_Rate_Forecast_body_Picture_6.png, USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

US Dollar / Canadian Dollar Interest Rate Trading Bias: Bearish

An important bounce in Bank of Canada interest rate forecasts has led to a similar move in the Canadian Dollar itself. Twelve month interest rate hike expectations for the Bank of Canada nearly doubled on a surprise jump in Canadian Consumer Price Index inflation data, warning that the central bank may need to move soon to counteract inflationary risks.

All else remaining equal, improved CAD rate prospects could keep the USDCAD lower. Yet the pair’s correlation to crude oil prices continues to trade near record-highs, and the Canadian Dollar’s trajectory may very much depend on moves in energy prices.

Watch future Bank of Canada interest rate decisions, CPI data, and the price of Crude Oil to guide Canadian Dollar price action through the foreseeable future.

US Dollar / Canadian Dollar Valuation Forecast

USDCAD Valuation Bias: Bullish

USDCAD_US_Dollar_Canadian_Dollar_Exchange_Rate_Forecast_body_07062011_CAD.png, USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

The disparity between USDCAD spot and PPP-implied exchange rates remains significant at 20.3 percent. Of all the majors, the so-called Loonie is the most sensitive to the implications of June’s QE2 expiration: first, its intimate correlation to the S&P 500 means that the response of market-wide risk sentiment to the likely rise in US borrowing costs will be mirrored in the USDCAD exchange rate; second, Canadian economic growth (and thereby its scope for interest rate hikes) is closely anchored to demand for the country’s exports from the US, so the degree to which higher yields slow the recovery in the world’s top economy will be critical for its Northern neighbor.

On balance, this seems point the way higher for USDCAD, for surely at least some slowdown in US economic activity is in the cards even if the recovery is not altogether derailed (easily the more probable scenario, in our opinion). This points the way lower for the S&P 500 and slashes hopes for any near-term monetary tightening on the part of the Bank of Canada, seemingly opening the door for USDCAD to trim the current valuation gap.

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 Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.

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