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Canadian Dollar Recovery in Sight for 2019 says ABN Amro

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- USDCAD rate to recover steadily through 2019 says ABN Amro.

- As oil rises and the BoC outpaces the Federal Reserve on rates.

- But GBPCAD to putter along sideways after December 2018 gain.

The Canadian Dollar will recover 2018's steep loss next year, according to the latest forecasts from ABN Amro, as the Bank of Canada (BoC) outpaces its U.S. rival and oil prices recover from the depths plumbed in recent months. 

Canada's Loonie has had a torrid 2018 as fears over the trading relationship with the U.S., which were the initial source of downward pressure heading into summer, gave way to renewed concerns about the oil price outlook.

This has put the USD/CAD rate on course to see in the New Year while still carrying a loss of around 6%, even as the Loonie has notched up minor gains over a Brexit-stricken Pound and the more risk-sensitive Australian Dollar. 

But 2019 will bring a reversal of fortune for the Canadia currency if ABN Amro is right about the oil market and Bank of Canada. It says the BoC will raise rates more than the U.S. Federal Reserve (Fed) next year and beyond. 

"So it is likely that Canadian yields will increase at a faster pace than US yields and at some point in time even surpass them. This is positive for the Canadian dollar," says Georgette Boele, a currency strategist at ABN. 

The Bank of Canada raised its interest rate by 25 basis points to 1.75% in October and said it will go on lifting its benchmark over coming quarters, potentially taking it up to 3.5% some time in 2020.

Across the southern border the Federal Reserve has kept the same pace in 2018 and also issued guidance suggesting it will lift its own rate potentially as high as 3.5% by the end of 2020. 

Markets are now attempting to work out which central bank will reach its interest rate summit first, and if either will blink in the face of mounting economic and financial market uncertainties that analysts anticipate will dominate 2019.

Boele and the ABN Amro team say the Fed will blink before the Bank of Canada and that this will lead to a broad softening of the U.S. Dollar, cementing a downward trend in the USD/CAD rate. They also anticipate the exchange rate will begin declining a long time before either central bank makes its next move. 

Above: USD/CAD rate (red & blue) alongside 2-year U.S-Canada yields spread (orange).

The USD/CAD rate is projected to end 2018 at 1.30 and to then decline to 1.27, 1.24, 1.20 and 1.18 over the four quarters of 2019. The Pound-to-Canadian-Dollar rate is forecast to rise from 1.68 to 1.71 before the end of 2018 and to hold that level through much of next year. 

Above: GBP/CAD rate (red & blue) alongside 2-year U.K.-Canada yield spread (orange).

"We also expect 2y US Treasury yields to come down once the Fed stopped its hiking cycle. We expect 2y Canadian government bond yields to rise a bit further in 2019 and 2020 because the rate hike cycle of the Bank of Canada will stop later," says Boele. 

Although grounds for ABN's bullish outlook for the Canadian currency relate to its interest rate forecast, those latter projections are based in part on an anticipated rise in the global price of oil. Oil is after all, Canada's largest export, although it remains to be seen whether the Canadian oil market with recover in line with the global one.

The bottom fell out of the oil market during October leading the global benchmark Brent crude to decline by 10% in that month alone, while Western Canadian Select plumbed fresh record lows.

Prices continued falling through November, prompting the Alberta government to require production cuts from local producers and the BoC to warn this week of an increasing threat to the economy.

Canada's central bank has now effectively backed away from earlier guidance that it would step up the pace at which it raise interest rates in 2019, dealing a crushing blow to the currency this week. 

But a very strong labour market has since suggested the economy may well be able to motor along at a decent clip regardless of recent events in the commodity space, injecting further uncertainty into the BoC outlook.

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