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USD/CAD Forecast: RSI Divergence Indicates Failed Test of January Low

USD/CAD Forecast: RSI Divergence Indicates Failed Test of January Low

2020-08-20 05:10:00
David Song, Strategist

Canadian Dollar Talking Points

USD/CAD extends the rebound from the monthly low (1.3133) following the Federal Open Market Committee (FOMC) Minutes, and the Relative Strength Index (RSI) indicates a failed attempt to test the January low (1.2957) as it deviates with price after struggling to push into oversold territory.

USD/CAD Forecast: RSI Divergence Indicates Failed Test of January Low

USD/CAD initiates a series of higher highs and lows as the FOMC mulls an outcome-based approach versus a calendar-based forward guidance for monetary policy, and the lack of momentum to test the January low (1.2957) may generate a larger rebound even though the central bank appears to be in no rush to scale back its emergency tools.

However, it seems as though Chairman Jerome Powell and Co. will stick to the same script at the next interest rate decision on September 16 as the central bank extends its lending facilities through the end of the year, and the unprecedented efforts taken by the FOMC may continue to produce headwinds for the Greenback as the committee votes unanimously to push back “the expiration of the temporary U.S. Dollar liquidity swap lines through March 31, 2021.

In turn, current market forces may carry into the month ahead as the FOMC notes that the recent decline in the balance sheet “was driven by the reductions in repo and U.S. dollar liquidity swaps outstanding,” and it remains to be seen if the crowding behavior in the US Dollar will persist as the central bank vows to “increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace.”

Image of IG Client Sentiment for USD/CAD rates

The IG Client Sentiment report shows retail traders have been net-long USD/CAD since mid-May, with 64.31% of traders net-long the pair as the ratio of traders long to short stands at 1.80 to 1.The number of traders net-long is 2.08% higher than yesterday and 2.74% higher from last week, while the number of traders net-short is 2.21% lower than yesterday and 16.45% higher from last week.

The rise in net-long position suggests the crowding behavior in the US Dollar will persist ahead of the next Fed meeting, while the rise in net-short interest comes as USD/CAD took out the March/June low (1.3315) during the previous week.

As a result, current market conditions may keep USD/CAD under pressure, but the decline from earlier this month has failed to push the Relative Strength Index (RSI) into oversold territory, with the indicator deviating with price as it appears to be reversing course ahead of oversold territory.

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USD/CAD Rate Daily Chart

Image of USD/CAD rate daily chart

Source: Trading View

  • Keep in mind, the USD/CAD correction from the 2020 high (1.4667) managed to fill the price gap from March, with the decline in the exchange rate pushing the Relative Strength Index (RSI) into oversold territory for the first time since the start of the year.
  • Nevertheless, USD/CAD reversed from the March low (1.3315) in June, with both price and the RSI carving an upward trend during the month, but the bullish formations have been largely negated as the exchange rate snapped the range bound price action during the first half of July.
  • USD/CAD managed to track the June range throughout the previous month as the RSI broke out of the downward trend established in July, but the failed attempt to push back above the 1.3440 (23.6% expansion) to 1.3460 (61.8% retracement) region has spurred a break of the March/June low (1.3315) even though the momentum indicator failed to push into oversold territory.
  • The RSI appears to be deviating with price as it reverses course ahead of oversold territory, but the failed attempts to break below 30 may indicate a potential exhaustion in the bearish price action rather than a change in trend as the 50-Day SMA (1.3462) continues to track a negative slope.
  • Keep in mind, a ‘death cross’ formation seemed to have taken shape in August as the 50-Day SMA (1.3462) crossed below the 200-Day SMA (1.3531), but the difference in slope undermines the bearish signal as especially as USD/CAD fails to test the January low (1.2957).
  • Lack of momentum to test 1.3110 (50% expansion) has pushed USD/CAD back above the 1.3170 (50% expansion) region, with the recent series of higher highs and lows bringing the 1.3250 (23.6% retracement) area on the radar.
  • Next region of interest comes in in around 1.3290 (61.8% expansion) to 1.3320 (78.6% retracement) followed by the Fibonacci overlap around 1.3440 (23.6% expansion) to 1.3460 (61.8% retracement).
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--- Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong

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