Sell the Canadian Dollar says CIBC, as Others Eye Period of Consolidation

Image © Pavel Ignatov, Adobe Stock

- USDCAD retreats further but is now "oversold" says CIBC. 

- Tells clients to buy USD/CAD as others eye consolidation.

- GBPCAD, EUR/CAD to decline says Scotiabank and Westpac.

The Canadian Dollar will fall over the coming weeks according to analysts at Toronto-headquartered CIBC Capital Markets, who have told clients they should sell the Loonie because it's New Year rally has now gone too far. 

Canada's Dollar has advanced steadily this January, dragging the USD/CAD rate down by -2.5%, as oil prices have begun to recover from last year's lows and markets in general have fallen out of love with the U.S. Dollar. 

"This is meant to be a short-term tactical trade to take advantage of the oversold nature of the pair. The CAD is still expected to take its near-term cue from developments in energy prices. Note that WTI is running into topside exhaustion in short-term charts," says Bipan Rai, a macro strategist at CIBC. 

Oil prices matter for Canada because crude and its refined derivatives are the nation's largest exports, which means the rebound seen across most benchmarks this January is good news for an economic.outlook that was badly dented in late 2018 by double-digit price declines.

WTI crude oil has risen 13% to $60 per barrell so far in the New Year, after having declined more than 30% between October and December 2018. Brent crude, the global benchmark, has followed a similar pattern while Western Canadian Select prices have picked up sharply too. 

These moves were the impetus for the Loonie's ongoing rally only the strategy team at CIBC say this rebound has now gone too far. The bank is betting in one of its portfolios that the USD/CAD rate soon returns to the 1.35 level, but says it could lift that target higher if momentum swings in CIBC's favour. 

"It could also be argued that the CAD rally seen so far in January looks excessive relative to the scale of the oil price move. USD-CAD has reversed close to 50% of the move higher seen during Q4 18, but the oil price has only recovered 25% of the ground lost. So while risk appetite may remain supported for now, we think a lot of good news is already in the price for the CAD," says Daragh Maher, U.S. head of FX strategy at HSBC

CIBC is not alone in saying the January rally has gone far enough already, as the currency team at HSBC wrote to clients last week saying they anticipate a period of "consolidation" for the USD/CAD rate during the weeks ahead. Maher says the 100-day moving average of 1.3180 should now act as support for the USD/CAD pair.

Above: USD/CAD rate shown at daily intervals.

The USD/CAD rate was quoted -0.27% lower at 1.3241 Tuesday and is now down -2.64% for the year-to-date, while the Pound-to-Canadian-Dollar rate was -0.80% lower at 1.6957 and has declined -2.54% in 2019. 

"GBPCAD has been choppy in the last week," says Eric Theoret, a technical analyst at Scotiabank. "The big, bearish reversal (weekly) off the recent range highs still rather suggests to us that the GBP will return to the lower end of the sideways range in place for the past 5 months sooner rather than later."

Above: Pound-to-Canadian-Dollar rate shown at daily intervals.

"Oil prices and terms of trade remain critical, given the stabilization in the outlook for relative central bank policy reflecting the BoC and Fed’s patiently neutral stance," says Shaun Osborne, a colleague of Theoret's and chief currency strategist at Scotiabank. "We remain medium-term CAD bulls but acknowledge the potential for a near-term consolidation in the absence of a continued rally in the price of oil."

Oil prices were a significant weight around the ankles of the Loonie late last year, but not the only one. The Bank of Canada's (BoC) interest rate policy has also been at play too, with December and January's about-turn on earlier guidance suggesting rates would rise at a faster pace this year having done severe damage to the currency.

The Bank of Canada raised its interest rate three times in 2018, leaving it at its current 1.75% level, and had suggested back in October that it would lift borrowing costs all the way up to the so-called neutral level during 2019 and 2020. It estimates the neutral point is somewhere between 2.5% and 3.5%. 

But the bank began to back away from that guidance in December following a series of disappointing economic figures and a rout in oil prices that saw Brent crude swap a near 20% gain for a 10% annual loss in the final months of the year. It completed its retreat from that earlier position in January.

The policy message is now that rates will still rise this year, but the bank will be much more cautious going forward. In other words, it is likely to lift interest rates at a slower pace in 2019 than it did last year. 

"Doubts about the BoC’s commitment to further policy normalisation continue to percolate but only a very bare +12bp in BoC hikes are now priced over their next six meetings to September 2019, a material decline from two months ago when rates markets discounted +70bp in BoC hikes over the same period," says Richard Franulovich, head of FX strategy at Westpac

Pricing in interest rate derivative markets suggest investors are currently unsure as to whether the Bank of Canada will even manage just one 25 basis point rate hike this year, which would easily prove to be too pessimistic a view, particularly if the Canadian economy holds up well over the coming months and quarters. 

Should economic data force the market to reconsider its view on the likely pace of BoC rate hikes in favour of pricing in more of them, then the Canadian Dollar would receive a powerful shot in the arm. 

Franulovich and the Westpac team recommended to their clients that they bet on a decline in the EUR/CAD exchange rate on Tuesday. Their rationale is that markets are too pessimistic in their outlook for the BoC, and that the Euro could easily underperform the Loonie during the weeks ahead because of economic concerns and the risk of the UK leaving the EU without having struck some kind of exit agreement that averts a return to trade tariff and a loss of European Commission budget income. 

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