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Canadian Dollar Forecast: Loonie Set to Soar? - Key Levels for CAD/JPY & USD/CAD

Canadian Dollar Forecast: Loonie Set to Soar? - Key Levels for CAD/JPY & USD/CAD

2020-07-22 15:00:00
Christopher Vecchio, CFA, Senior Strategist
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Canadian Dollar Forecast Overview:

  • The Canadian Dollar’s gains have slowed relative to other major currencies in recent weeks, against all but two of the majors: the Japanese Yen and US Dollar. Now, both CAD/JPY and USD/CAD rates are positioned for breakout opportunities in favor of Canadian Dollar strength.
  • A thin forex economic calendar through the end of the week will leave CAD-crosses at the whims of cross asset flows, centered around oil prices and equity markets.
  • According to the IG Client Sentiment Index, USD/CAD rates have a mixed trading bias in the near-term.
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Canadian Dollar Inching Higher, Breakouts in Sight

After a torrid rebound from its coronavirus pandemic lows in March, the Canadian Dollar has spent the past few weeks, particularly the month of July, taking a breather. But the lack of gains has not translated into a reversal; indeed, the Canadian Dollar, like its Australian and New Zealand Dollar commodity currency counterparts, remains one of the better performing major currencies since financial markets crashed out in March 2020.

Instead, with crude oil prices elevated and equity markets continuing to charge higher, CAD/JPY rates are positioned to test the topside of a multi-week sideways range, while the recent break in the DXY Index – signaling a potential long-term bearish trend for the US Dollar – now offers an opportunity for USD/CAD rates to drop below multi-year trend support.

Spot crude oil prices, trading at 41.33 at the time this report was written, recently touched their highest level since March 6. Accordingly, with energy markets buoyant and a Bank of Canada that is going nowhere fast, the Canadian Dollar remains on sturdy ground, finally ready to take flight against the historical funding currencies.

BOC Interest Rate Cut Expectations Stable

Bank of Canada interest rate expectations have been stable for several weeks at this point in time. At the end of April, there was a 55% chance of a 25-bps interest rate cut in December 2020, according to Canada overnight index swaps. But given gains in global equity and energy markets, and containment of the coronavirus pandemic within Canada’s borders, a bullish foundation has been laid for the Canadian Dollar. To this end, there is a 3% chance of a 25-bps rate hike through December 2020.

Bank of Canada Interest Rate Expectations (July 22, 2020) (Table 1)

Canadian Dollar Forecast: Loonie Set to Soar? - Key Levels for CAD/JPY & USD/CAD

It still holds that the Bank of Canada’s efforts along the interest rate front are finished. While the BOC has cut the main interest rate to an all-time low of 0.25%, there have been some signals to the market that it may not be done yet (see: the two most recent BOC meetings). If the BOC does anything else, it may not be to cut interest rates to zero – or to negative territory. Whereas the threat of negative rates looms for other major currencies (see: New Zealand Dollar), the Canadian Dollar is not haunted by this threat.

USD/CAD Rate Technical Analysis: Daily Chart (July 2019 to July 2020) (Chart 1)

Canadian Dollar Forecast: Loonie Set to Soar? - Key Levels for CAD/JPY & USD/CAD

Shifts in price action in recent weeks has provoked an evolution in our understanding of the short-term USD/CAD technical picture. While the downtrend from the March and May swing highs remains intact, focus has shifted to two potential triangles’ support: from the June and July swing lows, which broke on July 21; and from the January and June swing lows, which has yet to be reached. Yet it is not lost that the rising trendline from the September 2012 and September 2016 lows is also yielding ground; several key support levels are under duress.

Bearish momentum is starting to accelerate. USD/CAD rates are below their daily 5, 8-, 13-, and 21-EMA envelope, which is still in bearish sequential order. Daily MACD has turned lower below its signal line, while Slow Stochastics have started to reach oversold territory. Short-term momentum indicators suggest that more losses may be on the immediate horizon for USD/CAD rates.

USD/CAD Rate Technical Analysis: Weekly Chart (December 2016 to July 2020) (Chart 2)

Canadian Dollar Forecast: Loonie Set to Soar? - Key Levels for CAD/JPY & USD/CAD

There may no longer be a longer-term upside bias in USD/CAD rates as this narrative is under threat given the potential for the pair to break the rising uptrend from the September 2012 and September 2016 lows. In the event that this trendline does give way over the coming sessions, the longer-term view would shift from a bullish symmetrical triangle to a bearish double top.

IG Client Sentiment Index: USD/CAD Rate Forecast (July 22, 2020) (Chart 3)

Canadian Dollar Forecast: Loonie Set to Soar? - Key Levels for CAD/JPY & USD/CAD

USD/CAD: Retail trader data shows 60.21% of traders are net-long with the ratio of traders long to short at 1.51 to 1. The number of traders net-long is 3.73% higher than yesterday and 13.68% higher from last week, while the number of traders net-short is 15.26% higher than yesterday and 11.32% 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 (July 2019 to July 2020) (Chart 4)

Canadian Dollar Forecast: Loonie Set to Soar? - Key Levels for CAD/JPY & USD/CAD

CAD/JPY rates have sustained their climb back above the rising trendline from the 2009 and 2016 lows, giving life to the idea that the symmetrical triangle, having formed between early-March and mid-May, was a significant bottoming effort. Retaking the 2019 low and symmetrical triangle swing highs near 78.50, and maintaining the move above 78.50, has given credence to the idea that the bottom is in.

While finding rejection near 82.00 at the start of June, CAD/JPY rates have since traded sideways for the past two weeks, carving out a range between 78.03 and 79.65. With CAD/JPY rates rising above their daily 5-, 8-, 13-, and 21-EMA envelope, which is in bullish sequential order, Slow Stochastics rising back towards overbought territory, and daily MACD turning higher above its signal line, suggests that price action may be building towards a bullish breakout attempt.

Given the range between 78.03 and 79.65 (163-pips), the topside measured move would call for gains towards 81.27.

CAD/JPY Rate Technical Analysis: Weekly Chart (June 2007 to July 2020) (Chart 5)

Canadian Dollar Forecast: Loonie Set to Soar? - Key Levels for CAD/JPY & USD/CAD

Bigger picture for CAD/JPY rates: while there is much ground to be made up to get back to the 2020 highs established in late-February, breaking out above 78.50 has seen 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 – if not the long-term bottom – may have been established.

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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

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