The Canadian Dollar Probes February Highs but Analysts are Split on Whether Gains Can Last

Image © Bank of Canada 

- CAD 1st place in G10 as Fed weighs, Trump's reprieve lifts.
- Mexican agreement averts tariffs, spares USMCA relations.
- As market sells USD and GBP amid Fed retreat, Brexit fears.
- Scotiabank eyes further CAD gains as CIBC warns on outlook.

The Canadian Dollar was probing five-month has against its U.S. and UK rivals Monday but local analysts are divided over whether the Loonie can hold these lofty levels during the months ahead, with Scotiabank analysts projecting continued gains while CIBC Capital Markets looks for losses to resume in the weeks ahead.

Canada's Dollar was screening the best performing G10 currency of the most recent week on Monday after having risen sharply against rivals including the U.S. Dollar and Pound Sterling during recent days, which pushed the USD/CAD and GBP/CAD rates down 1.8% and 1.4% respectively. This left Sterling nursing a 3.4% 2019 loss Monday.

Gains were driven by a duo of supportive factors beginning with market bets against the Federal Reserve helping push both exchange rates lower during the first part of last week while a last minute reprieve for the United-States-Mexico-Canada-Agreement another shot in the arm at the Asian open Sunday night.

"There was good news on the trade front this weekend as the US and Mexico reached a deal that suspended tariffs on Mexican goods indefinitely. Of course, this still doesn’t change the fact that Trump will continue to use the threat of tariffs in negotiations in the future. That’s especially important to remember," says Bipan Rai, head of FX strategy at CIBC Capital Markets.

Above: Canadian Dollar performance Vs G10 rivals, one-week timeframe. Source: Pound Sterling Live.

President Donald Trump had threatened to impose a 5% tariff on goods imported from Mexico in an effort to force the neighbouring country to do more to prevent South American migrants from crossing its territory and attempting to gain illegal access to the U.S.

This came at a time when lawmakers on all sides were attempting to speed up ratification of the USMCA trade pact, which was put in doubt by the dispute. Anything that threatens the implementation of USMCA would pose a risk to the Canadian economy and Dollar because a loss of the pact would mean both Canada and Mexico losing preferential access to the U.S. market.

Analysts at TD Securities, another Toronto-headquartered firm, estimated amid the negotiations the Loonie would fall up to 20% if the North American Free Trade Agreement, USMCA's predecessor, was torn up. Trump made renegotiating NAFTA a key pledge in the 2016 presidential election campaign. 

"US trade policy making remain capricious and, with President Trump’s reasoning for lifting the tariff threat on Mexico under a fair degree of scrutiny, the pressure for a real “win” with China is perhaps all the greater now," says Shaun Osborne, chief FX strategist at Scotiabank. "The CAD is a relative out-performer, supported by hopes that the USMCA can now move forward. Last Friday’s contrasting US and Canadian employment data are also helping underpin the CAD still."

Above: USD/CAD rate shown at daily intervals.

 "A fresh three month high was tested in early Asian trade as market participants responded to the easing in U.S.-Mexico trade tensions. The market tone is constructive and the CAD remains fundamentally undervalued. Our estimated equilibrium incorporating yield spreads (2Y, 5Y) and oil prices (WTI) has USDCAD at 1.2987," writes Osborne, in a Monday briefing to clients. 

Osborne and the Scotiabank team are bullish in their outlook for the Canadian Dollar and are forecasting even further gains for the Loonie over its U.S. rival before year-end. The difference between Canadian and U.S. interest rates plays a key role in their forecasts. 

In what is now a contrarian call, Scotiabank forecasts the Bank of Canada will lift its interest rate by 25 basis points to 2% before year-end, while the Federal Reserve is expected to hold its rate steady at 2.5%. This the bank says, will push the USD/CAD rate down steadily through 2019, to 1.28 by the time the year is out. However, Pound Sterling is in for a rough ride against its Canadian counterpart during the weeks ahead.

"The GBP remains prone to a downside extension, following the break below the base of the bear triangle consolidation, in our opinion," says Eric Theoret, a technical strategist at Scotiabank. "This looks to be a slow-burning fuse for our core view that the cross is heading towards a test of key support at 1.6906 and a return to the 1.65/1.67 range."

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

"For the CAD, the rally should run into support levels in the coming week ahead of the Fed meeting on June 19th," says CIBC's Bipan Rai. "We’re expecting that USD/CAD will probe below the 1.3250 mark ahead of the Fed meeting. Below there, there is trend line support at the 1.3175 level and then additional support at 1.3050."

The CIBC Capital Markets team do not share Scotiabank's optimistic view, even though they've warned clients the ongoing rally higher by the Loonie could endure for a few more weeks yet. They say the Canadian currency will soon run into a cluster of resistance levels that bring its advance to halt. 

CIBC entered a 'long' USD/CAD position at 1.3475 earlier this year and is looking for a move up to 1.41, which would be the exchange rate's highest level since the early days of 2016 when the prices of the North American country's main export, oil, reached their lowest ebb in the 2014-2016 boom-to-bust turn.

"The longer-term strategic view shouldn’t change – the CAD needs to weaken. The move lower offers more attractive opportunities to get long. Keep in mind that we now have a BoC rate cut in our profile for the coming 12 months," Rai says, in a note to clients late Friday. 

Rai says CIBC's long-term view on the Canadian Dollar would only change if the USD/CAD rate falls below 1.2950. The bank's argument is that with a lack of transportation infrastructure strangling the Canadian oil industry while a series of other factors constrain growth in other sectors, the Loonie will need to weaken substantially over the long-term if the economy is to remain in business.


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