Pitfalls and traps on loonie’s way. Forecast as of 03.11.2021

Markets expect the overnight rate to rise by 125 bps in 2022, which, amid a strong oil market, makes one wonder why USDCAD is not falling? Let us discuss the Forex outlook and make up a trading plan.

Weekly Canadian dollar fundamental forecast 

It is hard to be the first. To be the first of the world’s leading central banks to raise rates. To be the first to taper QE. However, if a bank decides to take such a step, your currency can strengthen. The Bank of Canada’s unexpected tapering of the QE program has surprised investors and allowed the Loonie to confirm its status as the best 2021 G10 performer. At the same time, there are many pitfalls in the Canadian economy. BoC’s rivals, including the Fed, are on the alert, which casts doubt on the continuation of the USDCAD decline.

Unexpected events serve as the most common reason for wide fluctuations in exchange rates. Markets expected that the Bank of Canada would announce the tapering of QE from CA$2 billion to CA$1 billion per week at its October meeting. However, instead, the BoC completely abandoned the program, announcing the start of the reinvestment phase. The BoC will buy bonds worth CA$4-5 billion a week from November using redeemable securities. As a result, the central bank’s balance sheet will remain at current levels, which means that monetary policy will remain easy. Investors reacted to the BoC surprise news by selling Canadian debt, which led to higher yield spreads with US counterparts and a USDCAD decline. However, this will not last long.

Dynamics of the Canadian and US bond yield spread

 

Source: Bloomberg.

At a press conference following the BoC meeting, Tiff Macklem noted that the Canadian economy is approaching a full recovery, so it does not need QE. At the same time, the Bank of Canada predicts an earlier return of GDP to the trend, which should occur in the first half of 2022. Although earlier, BoC officials expected this to happen in the second half of 2022. As a result, the derivatives market began to signal an increase in the overnight rate in January. Moreover, by the end of next year, borrowing costs may rise by 125 bps.

It remains a mystery how the Canadian dollar does not continue to confidently strengthen against the backdrop of aggressive monetary restrictions and a very strong oil market? This is due to doubts that the economy of Canada is doing well. In September, GDP remained virtually unchanged, and in the third quarter, it expanded slightly by 0.5% QoQ and by 2% YoY. The cut in economic growth forecasts for 2021 by the Bank of Canada from 6% in July to 5.1% further raises doubts that the overnight rate hike in 2022 will be steep.

However, the problems of the third quarter could be caused by an increase in COVID-19 cases. In October, the situation began to change for the better, which allows us to expect the fourth quarter with optimism. Moreover, if Brent’s price also grows to $120 per barrel, as predicted by Bank of America, then the USDCAD downtrend will quickly recover.

Weekly USDCAD trading plan

In the meantime, the bears will have to “survive” the FOMC meeting and the release of the US and Canadian job reports for October. These reports are released at the same time, which allows selling USDCAD towards 1.2295 in case of positive news from Canada and its inability to stay above 1.2395. On the contrary, weak Canadian statistics will be an argument in favor of the correction development.

    

Price chart of USDCAD in real time mode

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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