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Canadian Dollar Forecast: Is USD/CAD Still Bullish as Breakout Stalls?

Canadian Dollar Forecast: Is USD/CAD Still Bullish as Breakout Stalls?

Rich Dvorak, Analyst

CANADIAN DOLLAR FORECAST: USD/CAD PRICE ACTION HITS RESISTANCE – LOONIE COULD STILL HEAD LOWER AS BANK OF CANADA ACTS TO OFFSET CRUDE OIL CRASH & CORONAVIRUS IMPACT

  • USD/CAD price action skyrocketed over 10% year-to-date
  • The Canadian Dollar breakdown follows a crash in crude oil
  • Bank of Canada could cut interest rates further and send the Loonie lower

A parabolic climb in spot USD/CAD over the last three months pushed Canadian Dollar lower by nearly 13% to the weakest reading against its USD peer since January 2016. The plunge in the Canadian Dollar, or Loonie, comes amid the crude oil price war and surging US Dollar.

USD/CAD PRICE CHART: MONTHLY TIME FRAME (AUGUST 2001 TO MARCH 2020)

USDCAD Price Chart Canadian Dollar Forecast

USD/CAD soared above the 1.46 handle this past week, but the Canadian Dollar recovered a bit of lost ground during Friday’s trading session as spot prices hit resistance. The January 2016 swing high of 1.4690 stands out as a clear technical barrier for USD/CAD price action. This level of confluence is also highlighted by the 76.4% Fibonacci retracement of the FX pair’s lifetime range.

SPOT USD/CAD & CRUDE OIL PRICE CHART: DAILY TIME FRAME (OCTOBER 2018 TO MARCH 2020)

USDCAD price chart Canadian Dollar Crude Oil Correlation

Chart created by @RichDvorakFX with TradingView

Crashing crude oil prices has pressured the Canadian Dollar lower versus major currency pairs considering the Canadian economy is highly dependent on oil and energy exports. The commodity trades more than 60% off its year-to-date highs following the novel coronavirus outbreak and oil price war sparked by Saudi Arabia.

The sharp drop in oil is expected to “weigh heavily on the economy and particularly in energy intensive regions” according to the Bank of Canada, which largely motivated an emergency interest rate cut announced last week. Even after slashing its policy interest rate by 100-basis points already this month, BOC Governor Stephen Poloz stated in a press conference late last week that the Governing Council could reveal more emergency action if needed.

CANADIAN DOLLAR TO USD BASIS SWAP UNDERSCORES FX LIQUIDITY STRAIN

Bank of Canada turns dovish to offset coronavirus impact and oil price plunge

Amid liquidity and funding market distress, largely due to a worldwide USD shortage, the cost to hedge currency risk via cross-currency basis swaps have surged. This likely exacerbated the upswing in the US Dollar versus its Canadian Dollar counterpart as market demand for safe-haven currencies balloons due to the deepening coronavirus pandemic.

Although, the Bank of Canada just entered a US Dollar swap line arrangement with the Federal Reserve last Friday to boost liquidity. In turn, this could alleviate some of the strain recently exerted on the financial system and facilitate a pullback in spot USD/CAD price action as liquidity is restored.

CHART OF USD/CAD RISK REVERSAL SUGGESTS MORE PAIN AHEAD FOR THE LOONIE

USDCAD Price Chart Canadian Dollar Risk Reversals

FX traders have grown increasingly bullish toward USD/CAD judging by the latest risk reversal measures. The three-month call put skew for USD/CAD was clocked at 4.3175 on Friday, which is its highest reading in at least 15 years. A risk reversal reading above zero indicates that demand for call options, or upside protection, outpaces that of put options, or downside protection.

That said, there might be potential for the Canadian Dollar to continue its slide if oil prices remain under pressure and coronavirus fallout continues to weigh on trader sentiment. Considering that the Bank of Canada still has capacity to cut interest rates further before reaching the zero-lower bound, and how Governor Poloz stated that the BOC “stands ready to provide all measures the financial system needs,” additional monetary policy action could be warranted, which would likely stand to weigh negatively on the Loonie and catapult USD/CAD higher.

Read More: US Dollar Climbs as EUR/USD Eyes 2017 Low, USD/JPY & USD/MXN Explode

-- Written by Rich Dvorak, Analyst for DailyFX.com

Connect with @RichDvorakFX on Twitter for real-time market insight

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

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