Cod0111816cad PNG

What’s Happening?

Canadian Dollar (CAD) pairs have the potential to be really active this week. For the last year, the loonie has been declining against USD and other major non-resource currencies generally tracking the decline in the oil price.

 

The relentless pressure of the last three months, however, has left CAD extremely oversold on a technical basis opening the potential for a rebound. We may also be seeing signs of a technical extreme to kick off this week.

 

In addition to oil related and technical trading, Canadian Dollar pairs could be particularly active this week around Wednesday’s Bank of Canada meeting and interest rate decision. Speculation has been growing that there could be another rate cut, but the jury remains out and the 50-50 feeling around the street suggests that regardless which way the decision goes, there could be significant trading action as a number of traders could be forced to scramble to get back on side.

 

Fundamentals:

 

As a major exporting country, Canada’s Dollar has historically been sensitive to  swings in commodity prices. CAD has particularly been sensitive to swings in the oil price and sentiment toward the United States, Canada’s main export customer.

 

For the last three months, the loonie has been steadily sinking along with the WTI oil price. In the last week, pressure on CAD increased significantly on growing speculation that the Bank of Canada could cut interest rates at Wednesday’s meeting.

 

A rate cut is not a sure thing, however, but whatever happens we could see significant trading action on the news.

 

Those in favour of a cut may point to the potential impact of a lower oil price on the Canadian economy, in particular that it could lead to more layoffs in oil producing regions and that the economy could use a boost from a lower rate. Also, having cut rates in January and July of 2015, some may see the central bank as being due for another cut if it continues that pattern.

 

Those in favour of holding may suggest, however, that the Bank of Canada has preferred to use the falling Dollar as its main tool for rebalancing the economy, and that the job gains of the last two months indicate that rebalancing is underway. (The negative impact of the oil crash hit sooner, while the benefits of the lower loonie on exports, manufacturing, shopping and travel patterns and other benefits take longer to emerge). The loonie is down 17% from a year ago and 12% from 6 months ago already, how much more stimulus would a quarter point cut really add compared with the currency decline?

 

There are some negatives to a lower loonie, such as higher prices for imported food which can impact consumer spending and as we saw in the 1990s, the loonie could eventually reach a point where the Bank of Canada’s ability to cut rates further could be limited. Concerns about what lower rates could do to red hot housing markets in some cities may also keep the Bank on hold.   

 

 

Technicals:

 

This daily chart shows that since mid-October in particular, USDCAD has been relentlessly climbing (CAD weakening relative to USD). The RSI indicator shows that the pair has become massively overbought and a double top suggests that the uptrend could be peaking.

 

Another sign of a potential top has emerged this week with a bull trap or buying climax where they pair broke out to a new high on trend, touched $1.4600 and has started to fall back with initial support at the $1.4500 round number. This suggests that the bulls (CAD bears) may be starting to lose their stranglehold on the markets.

 

Recent price action and suggests that traders have already priced in a high probability of a rate cut. As we saw last month when the Fed finally raised rates, and USD stayed steady, the loonie may not fall any further on a Canada rate cut.

 

On the other hand, with CAD so overextended technically, if the Bank of Canada doesn’t cut rates, the loonie could stage a big snap back relief rally that could send USDCAD sharply lower.  Initial downside support may appear near $1.4390 or $1.4330, but a significant correction could take the pair back toward $1.4200 or even $1.4000 over the medium term based on common Fibonacci retracements.