Canadian Dollar Forecast Overview:
- The Canadian Dollar has stabilized as energy prices have rebounded in recent weeks. But a more significant move may not be on the horizon until risk appetite shifts in a more profound manner.
- Pairs like CAD/JPY and USD/CAD have continued to tighten in ranges over the past six weeks, leading to potential for both bulls and bears alike.
- According to the IG Client Sentiment Index, USD/CAD rates have a mixed trading bias in the near-term.
Canadian Dollar in Holding Pattern
The Canadian Dollar has proven stable in recent weeks following a dramatic turn lower in March, guided to the downside by energy markets amid the fallout from the coronavirus pandemic. But the rebound in WTI crude oil prices, the North American benchmark, as well as Canada’s Western Canadian Select oil prices, has given energy-sensitive currencies like the Loonie an opportunity to stem losses.
And so, whereas the stability afforded to the Canadian Dollar up until this point in time has hinged on a rebound in energy markets, it may hold that the Canadian Dollar has now turned its attention to broader risk appetite. Now that segments of both the American and Canadian economies are opening back up, we may be entering the ‘reality check’ zone for market participants, who have otherwise proven jubilant against the worst economic backdrop in modern history.
BOC Interest Rate Expectations Begin to Weigh
The Bank of Canada’s efforts along the interest rate front may not be complete after all. Despite immediately cutting the main interest rate to an all-time low of 0.25%, the BOC has been offering some signals to the market that it may not be done yet. At the April BOC policy meeting, rates were kept on hold while new financial market stability mechanisms were announced in order to help keep credit flowing to businesses and households. Since then, interest rate expectations have slowly been dragged forward.
Bank of Canada Interest Rate Expectations (May 21, 2020) (Table 1)
According to Canada overnight index swaps, rates markets think that the BOC is going to move on rates again by the end of the year, even if more is being done to gear-up extraordinary policy efforts. One month ago, through the end of the year, there was only a 5% chance of a rate cut materializing; now, overnight index swaps are pricing in a 55% chance of a 25-bps interest rate cut in December 2020.
USD/CAD Rate Technical Analysis: Daily Chart (May 2019 to May 2020) (Chart 1)
Whereas it had appeared that a descending channel had been carved out relative to the March and April swing highs, price action in USD/CAD rates in recent weeks has shifted attention to the sideways range if not descending triangle forming. USD/CAD rates have been rangebound between 1.3855 and 1.4265 since the end of March, and until this range breaks, there’s little reason to believe a significant move is nearby.
To this end, USD/CAD rates are above their daily 5, 8-, 13-, and 21-EMA envelope – which happens to be in bearish sequential order. Daily MACD’s decline into bearish territory below the signal line appears to be slowing, while Slow Stochastics have started to rise ahead of a drop into oversold territory.
As was the case in our last USD/CAD update one month ago, “given the context of the market environment and USD/CAD price action, traders may be apt to wait for further confirmation that continuation to the upside will develop before entering into any trades.”
USD/CAD Rate Technical Analysis: Weekly Chart (December 2016 to May 2020) (Chart 2)
It still holds that, “in the event of a short-term USD/CAD rate reversal to the downside, the longer-term bias may still be higher for the pair. On the weekly timeframe, USD/CAD rates remain well-above their weekly 4-, 13-, and 26-EMA envelope. Although Slow Stochastics are pulling back from overbought territory, weekly MACD continues to trend higher in bullish territory.” This commentary from April 7 remains valid.
IG Client Sentiment Index: USD/CAD Rate Forecast (May 22, 2020) (Chart 3)
USD/CAD: Retail trader data shows 60.56% of traders are net-long with the ratio of traders long to short at 1.54 to 1. The number of traders net-long is 15.14% lower than yesterday and 69.95% higher from last week, while the number of traders net-short is 4.48% lower than yesterday and 31.01% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USD/CAD prices may continue to fall.
Positioning is less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed USD/CAD trading bias.
CAD/JPY Rate Technical Analysis: Daily Chart (May 2019 to May 2020) (Chart 4)
CAD/JPY rates had been consolidating inside a symmetrical triangle since early-March, yielding an attempt at a topside breakout earlier this week. But the effort appears to have failed, running into significant long-term resistance in the form of the rising trendline from the 2009 and 2016 lows. This truncated move has occurred prior to CAD/JPY rates retaking the 2019 low and symmetrical triangle swing highs near 78.50, suggesting that more weakness may materialize soon yet.
One month ago, in the last CAD/JPY rate forecast update, it was noted that “CAD/JPY rates have not been able to climb back above the rising trendline from the 2009 and 2016 lows – support for the past decade. Failure to re-establish itself through the August 2019 low at 78.50 is a necessary precursor to any trades taken from the long side, in this strategist’s opinion.” This remains the case.
CAD/JPY Rate Technical Analysis: Monthly Chart (June 2007 to May 2020) (Chart 5)
Bigger picture for CAD/JPY rates: there is much ground to be made up to get back to the 2020 highs established in late-February. But clearing out 78.50 will also see CAD/JPY rates rise above the descending trendline from the October 2018 and July 2019 lows, offering another piece of evidence that a near-term low may have been established.
It’s still too early, however, to say that the worst is over yet for CAD/JPY: without clearing out 78.50, the loss of the uptrend from the 2009 and 2016 lows could prove long-term detrimental for CAD/JPY rates.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
