Canadian Dollar Could become Target for Short-sellers amid Fresh U.S-China Trade Tensions

Image © Pavel Ignatov, Adobe Stock

- CAD in sights of short-sellers amid fresh U.S.-China tensions. 

- CAD/JPY vulnerable if U.S. raises tariff rates on Chinese goods.

- USDCAD seen supported as GBPCAD hovers around 1.75 level.

The Canadian Dollar could become a target for short-sellers over the coming days if markets are right in fearing an imminent escalation of the so-called trade war between the world's two largest economies, some analysts say. 

Canada's Dollar would be vulnerable to losses against its U.S. rival as well as the safe-have Japanese Yen this Friday if the White House decides to increase the tariffs levied on U.S. imports of Chinese goods. 

President Donald Trump said Sunday that China had reneged on earlier trade commitments and warned that the White House would go ahead with an earlier plan to more than double, to 25%, the tariff rate charged on the country's exports to the U.S. as soon as Friday.

The White House had suspended that earlier plan "indefinitely" on March 01, after China agreed to enter talks aimed at addressing U.S. concerns over its trade practices. But there was always a caveat to that suspension requiring good faith negotiations that culminate in a deal.

Vice Premier Liu He is in Washington for talks over China's "unfair trade practices" Thursday and it still remains to be seen whether an agreement to avoid a further escalation of the grade conflict can be reached. But if one can't, it could spell bad news for the Canadian Dollar. 

"KRW, CAD and IDR tend to have the highest betas to the CNY. While we note the dollar is still performing well, we are a little worried that US equity markets could start to suffer if those tariffs go into effect and thus would prefer to hold defensive positions in the JPY. Short CAD/JPY positions could become popular for the short term, given that the CAD is not an expensive sell," says Chris Turner, head of FX strategy at ING Group

Above: CAD/JPY rate shown at daily intervals.

Canada's currency is underwritten to some extent by the nation's oil trade with the U.S., which means it is sensitive to fluctuations in prices. The oil market would be at risk of declines if the U.S. and China were to slug it out again in a tariff fight as this would stoke fears for global growth and oil demand. 

The White House has already targeted $250 bn of China's annual exports to the U.S. with tariffs since March 2018, with some $50 bn already subject to levies of 25% and the remainder still only subject to a rate of 10%. That 10% rate will increase Friday unless President Trump decides otherwise. 

Trump has also long been threatening to target the remaining $267 bn of China's annual exports to the U.S. if a deal ending "unfair trade practices" including alleged intellectual property theft cannot be agreed during the course of Thursday. China has threatened to retaliate if the U.S. does lift its tariffs.

"We look for another tense session of headline chasing for markets generally and feel that the risk off mood is likely to persist at least into the conclusion of the US/China talks. As such, we expect the JPY to remain well-supported – reflecting the “seasonal” bid for the currency that typically emerges around this time of the year," says Shaun Osborne, chief FX strategist at Scotiabank

Above: USD/CAD rate shown at 4-hour intervals.

Scotiabank's Osborne is more optimistic in his outlook for the Canadian Dollar, describing the trade conflict as something that will prevent the Loonie from recovering ground previously lost to its U.S. rival over the short-term but not necessarily causing it much fresh harm.

"CAD is quietly consolidating within an incredibly tight range, testing a marginal two week low but struggling to extend much beyond levels observed in the aftermath of President Trump’s weekend tweets," Osborne writes, in a note to clients. "Yield spreads and oil prices are offering considerable support however, and the CAD is trading well below our FV estimate (USDCAD 1.3308)."

The Pound-to-Canadian-Dollar rate is projected, by Osborne's colleague Eric Theoret, to remain supported around its current 1.75 level this week. 

"The undertone may remain soft in the short-term as the market corrects recent gains. However, the broader tone here—determined by the GBP-bullish move above the 40-day MA and bullish trend signals on the medium and longer term studies—suggests limited downside risk for the GBP at this point. We look for support on softness to the 1.7500/50 range," Theoret says.

Above: GBP/CAD rate shown at 4-hour intervals.

Trade headlines could easily be a source of volatility for the Loonie over the coming days but the longer-term outlook will be determined almost entirely by the outlook for Bank of Canada interest rate policy and perceptions of how Canadian cash rates will compare with those available elsewhere. 

The Bank of Canada has all-but abandoned its rate hiking cycle and its official position is now that interest rates could either go up or down in the next change, which is a policy shift that was brought on in part by the global economic impact of the U.S-China trade conflict. 

Both Chinese and Eurozone economies have slowed since the U.S. tariffs were implemented in the middle of 2018 and many analysts expect the U.S., which is Canada's largest trade partner, to also slow this year. Canada's economy weakened too. 

Canadian GDP growth nearly halved in 2018, falling from 3% previously to just 1.8% last year. That was mostly the result of a -30% final quarter fall in oil prices but the Bank of Canada has also identified trade uncertainties as a significant impediment to business activity in some sectors.

"Growth during the first half of 2019 is now expected to be slower than was anticipated in January. Last year’s oil price decline and ongoing transportation constraints have curbed investment and exports in the energy sector. Investment and exports outside the energy sector, meanwhile, have been negatively affected by trade policy uncertainty," the BoC told markets in April. 

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