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Bank of Canada preview: where next for USDCAD?

Summary

  • The Bank of Canada is about to decide on rates today, market is split in expectations
  • USDCAD has slipped below 1.24 for the first time since 2015
  • Canadian dollar enjoys full backing of the economy and the bond market, could extend its rally

Most of the market attention this week in on the ECB and for the right reasons. The euro is one of the big time winners this week and Mario Draghi could extend this streak by signalling policy reversal on Thursday. However, traders should not look though the Bank of Canada meeting today. The Canadian economy has seen a turnaround this year and the Bank has already responded with higher rates and could do so again. This in turn has translated into much stronger CAD. What to expect from the BoC today? What’s next for USDCAD?

The Canadian economy is booming

A moderate interest of the financial community in the shape of the Canadian economy could be coming from the fact that it’s assumed to be doing more less like the US – it’s most important trading partner. However while the US economy has been struggling somewhat this year Canada has been literally booming. Economic growth increased to nearly 4.5% in the second quarter showing a very healthy structure, it was fed by consumption, investments and net exports. Growth has now averaged 3.75% over the past 4 quarters compared with just 2.6% for the US. Inflation remains below the target but with unemployment rate falling like a stone, the BoC can feel secure about the prospects in this regard. 

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GDP growth in Canada accelerated in the second quarter. Source: Macrobond, XTB Research 

Furthermore, worries about the oil sector could be misplaced as well. It is true that some of the production in Canada has high marginal costs but let’s look at the extraction sector – it’s skyrocketing, pulling the whole industry along. Canada was struggling with oil at $30 but seems to be more than ok with prices around $50 per barrel. 

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Oil industry in Canada is doing well even at prices around $50/barrel. Source: Macrobond, XTB Research 

BoC is bound to increase rates again

Suddenly the Bank of Canada found itself behind the curve and the message it sends after hiking rates in July is that it needs to act quickly. For that reason markets believe that interest rate hike will take place no later than October but some bet it could occur as soon as today with another hike in the first half of 2018.

Could USDCAD tank below 1.24 for good?

USDCAD has slipped below 1.24 for the first time since 2015. The pair looks oversold short-term wise but when we take a longer term view it remains high. Furthermore, unlike with the EURUSD, the pair has a full backing of the bond market. In fact, the spread between the US and Canadian 10 year bonds has not been that tight since 2014. So from the bond market perspective the pair could see lots of downside in a longer horizon.

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10-year bond spread between the US and Canada has not beet this thin since 2014. That could argue for more declines on USDCAD. Source: Bloomberg, XTB Research  

Technically we could draw a long term trend line which still needs to be broken but it has not been tested for a long time and its importance could be doubted. Meanwhile the next relevant level is as far as 1.1940. 

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USDCAD slipped below 1.24 a technically could see a space for declines below 1.20. Source: xStation5 

However, traders should keep in mind that positioning in the CAD is close to multiyear highs so a lack of the move in rates today (even if that’s the consensus) could trigger a short term correction. To sum up, traders could consider waiting for the move from the BoC. A hike today could be a signal for more decline to come. On the other hand, should the BoC refrain from the move, traders could look for higher levels to consider selling USDCAD as prospects for the bears remain favourable in any case.     

 

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