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USD/CAD Technical Analysis: On the Cusp of a Big Drop as Oil Stumbles?

USD/CAD Technical Analysis: On the Cusp of a Big Drop as Oil Stumbles?

Tyler Yell, CMT, Currency Strategist


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Talking Points:

A Behavioral Change on the Horizon?

USD/CAD seems to have peaked in Mid-January, and now questions turn to whether or not the CAD will quietly take over. We have seen a divergence of Oil & USD/CAD from its prior lock-step relationship. Oil is still important, and the volatility of Oil continues to see CAD rally with Oil, but surprisingly CAD does not fall as much as it died in Q4 2015 when Oil falls ~6% in a day like it did on Tuesday. For our long-term Oil outlook, check it out here.

One development that continues to get little attention but appears to be very important to the direction of USD/CAD is the 2-yr yield spread between the United States & Canada. The 2-year yield narrowing shows that investors are pricing in more dovish action, even if inaction from the Fed than they are from the Bank of Canada. Canada’s inflation readings have remained rather steady despite Oil’s drop thanks to exports, and such a balance could make USD/CAD one of the great reversion to the mean moves of 2016 if the Fed continues to hold at 0.375 instead of hiking later this year. The 2-yr yield spread has narrowed from -60bp to -26.4 currently, which is a 3-month low.

USD/CAD Has Broken Below Ichimoku Cloud, a Long-term Trend Following Indicator

Key Levels after the Plunge

The key level remains the 100-dma at 1.3618, which also aligns with the 38.2% retracement of the May-January range. A break below 1.3618 would align with what we see on Ichimoku, which is price breaking below the cloud that could spell more downside is ahead.

Should price breakdown, the first price support would be the September high of 1.3456. A further breakdown, which would likely align with a further narrowing of the 2-yr yield curve, would be the 50% & 61.8% retracement. The 50% retracement of the May-January range is at 1.3303, and the 61.8% of 1.2977 that would likely need a strong drop in the US Dollar to accomplish.

Canadian Dollar Rally is Set to Last per Sentiment

When looking at sentiment, crowd sentiment has moved back to a negative bias relative to recent positioning. We use our Speculative Sentiment Index as a contrarian indicator to price action, and the fact that the majority of traders are net-short means a bullish signal is currently at play. How price reacts around the 100-dma will be critical. A break below this key support metric and a move into positive territory on the SSI would favor further downside towards downside targets mentioned above.

Combining the technical picture above, with the sentiment picture, a break below support of the long-term channel and 100-DMA alongside a move higher in retail sentiment to net long against a potential new trend would further warn of more CAD gains ahead.

USD/CAD Speculative Sentiment Index as of 2/24/2016

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