After a weak start, the USDCAD bears are going ahead. The rise in oil prices, strong reports on Canada’s inflation, employment, and foreign trade support the local currency. Let’s discuss the CAD outlook and make up a trading plan.
Weekly Canadian dollar fundamental analysis
The highest in decades inflation and the associated cost of living crisis make the actual government point fingers. Central banks often become the ones to blame. They went too far with monetary stimulus in 2020 and suspended the stimulus withdrawals for too long. The UK Parliament criticizes the Bank of England governor. The same happens in other countries, including Canada, where the BoC is preparing for another rate hike.
A tight labour market, with unemployment at a record low of 5.2%, coupled with inflation at 6.8%, makes the Bank of Canada continue its aggressive monetary tightening cycle. A FOMC hawk, Christopher Waller, agrees with the market estimate of raising the federal funds rate to 2.65%, while investors expect Tiff Macklem and his fellow central bankers to raise the overnight rate to 3% by the end of 2022.
Dynamics of skilled labour shortage in Canada
So, the Fed is not the most aggressive central bank. On a 12-month horizon, derivatives suggest a 250-basis-point rate hike by the Fed, a 180-basis-point rate increase by the Bank of England, and a 100-basis-point rate hike by the ECB. The Bank of Canada is likely to go even further. The derivatives market expects it to increase borrowing costs by half a point in May, by the same amount in July, followed by a smaller step of 25 basis points.
The monetary policy tightening puts pressure on inflation expectations, increasing the purchasing power of the local currency in the future and strengthening its exchange rate. Furthermore, both the foreign environment and domestic data support the Loonie. So, the CAD rally against a basket of major currencies looks natural.
In Q4, Canada’s current account deficit was CA$137 million, and in the January-March period this year, it has a surplus of CA$5 billion. This is the biggest surplus since the second quarter of 2008, supported by the favourable conditions in the commodity market. The gradual lifting of restrictions in China, which, according to Standard Chartered, reduced its oil demand by 1.2 million bpd, and the EU embargo on Russian oil encourage the USDCAD bears. Although offshore oil imports have been banned, the oil supply is 2.8 million bpd.
I suppose one could buy the Loonie due to the bullish commodity market, including the rise in oil prices, Canada’s strong economic data, and the BoC’s willingness to tighten monetary policy aggressively. The matter is against which currency one should buy the CAD. I suggest looking at the Treasury yield. If the Treasury yield resumes growing, one could sell the EURCAD if the price breaks out the support at 1.355. If the US bond yield remains stable or starts declining, one could enter the USDCAD shorts with targets at 1.25 and 1.23.
Price chart of USDCAD in real time mode
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