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USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

2011-10-06 17:55:00
Joel Kruger, Technical Strategist, David Rodriguez, Quantitative Strategist, and Ilya Spivak, Currency Strategist,
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Monthly Chart

US_Dollar_Canadian_Dollar_Exchange_Rate_Forecast_body_EUR10.png, USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

Prepared by Joel Kruger

Inability to break to fresh record lows below 0.9000 in 2011 has opened the door for a more meaningful bullish reversal, with the market now carving out what we believe to be a significant longer-term base. From here, any setbacks should be well supported by parity, with a fresh higher low sought out by the psychological barrier ahead of the next major upside extension towards 1.1000-1.1500 further up.

US Dollar / Canadian DollarInterest Rate Forecast

Currency, Central Bank

US Dollar, US Federal Reserve

Canadian Dollar, Bank of Canada

Net USDCAD Spread

Signal

1-Year Expectations(Basis Points)

10

(39)

49

Bullish

Yield in 1 Year(Percent)

0.35

0.62

(0.26)

Bearish

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: Bullish

A significant turn lower in Canadian interest rate forecasts have forced similarly sharp Canadian Dollar weakness (USDCAD strength). Yet the biggest mover remains broader trends in commodity prices—particularly as Crude Oil futures see significant volatility through recent trading.

According to our correlation studies, the short-term link between the NYMEX WTI Crude oil contract and the USDCAD trades near record strength. A recent breakdown in commodity prices offers little support for the Canadian currencies. Generally dour Bank of Canada expectations likewise show the currency will receive little yield-link support.

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 Forecast: Bullish

US_Dollar_Canadian_Dollar_Exchange_Rate_Forecast_body_Picture_7.png, USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

Source: Bloomberg

The disparity between USDCAD spot and PPP-implied exchange rates has narrowed from the extremes but remains very significant at over 1500 pips. An intimate inverse correlation with the S&P 500 points to more of the same as risk aversion continues to grip financial markets, with sentiment battered by the lingering EU debt crisis and a slowing global recovery. The sharp slide in Bank of Canada rate hike expectations is also not dong the Loonie any favors, reinforcing the likelihood of an upside scenario in the weeks ahead.

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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