BMO Say Canadian Dollar Weakness Forecast on Political Uncertainty
- Written by: Gary Howes
The Canadian dollar is on the offensive but a return to weakness is forecast by analysts at BMO Capital who suggest political uncertainty is not fully priced into the CAD.
Bank of Montreal (“BMO”) have told clients that their forecasts take in a weaker Canadian dollar as the month progresses.
One notable driver behind such downside risk lies with politics and the failure of currency markets to adequately price in the upcoming general election.
However, for now it appears that the movement in commodity prices will be the prime driver in CAD.
Global commodity prices - notably oil - have rebound strongly over the course of October, providing positive background music for the Canadian dollar.
The relationship between commodity prices and the Canadian dollar is strong according to BMO Capital.
BMO say that amongst the variety of financial variables that they track, the variable that stands out as being the best out-of-sample predictor of USDCAD over the last three months is the CRB commodity price index: 
The CRB fell 4.1% in the month of September, the energy complex was hit particularly hard. West Texas Crude fell 8.4%.
The Western Canada Select blend spot price fell 10.2%. Natural gas fell by 6.1%. The Bloomberg base metals index fell by 0.1%.
This saw the Canadian dollar weaken notably with the USDCAD exchange rate rallying from 1.31 at the beginning of September to 1.33 at the close of the month.
It briefly reached an eleven-year high above 1.34 as the month wound down.
The subsequent turnaround in commodity prices has seen the Canadian dollar reverse direction and push the USDCAD to 1.3020 at the time of writing.
However, the forecast at BMO Capital prices in CAD declines from here.
In their October strategy update the bank say:
“Our preferred trading strategy for October would be to accumulate a long USDCAD position below 1.3150 with a trailing stop around 1.3020. We would look to take partial profit on the long above 1.3400 and full profit around 1.3800.”
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Elections Not Adequately Priced into the Currency
Another variable to watch with regards to the CAD’s outlook is political in nature.
“We don’t think the market has fully digested the election; we can’t recall a quieter one in terms of FX market attention. Given the uncertainty (and potential disappointment) the election brings, the FX Strategy team has a 1M target of 1.34,” say BMO.
This would effectively return USDCAD to its September highs.
Forecasters at BMO Capital are targeting 1.35 at the 3M horizon, which now spans the December FOMC and the critical Q4 retail season.
“For that horizon, we believe that either the Fed will hike and push USDCAD to at least 1.35 or else risk-off sentiment will drive USDCAD to 1.35. We acknowledge the possibility of alternative scenarios,” say BMO.
For example, a Conservative comeback that rivals the one seen earlier this year in the UK along with a bounce in oil prices above $50/bbl for WTI could push USDCAD below 1.30 and trigger a minor cascade of stops.
“We just wouldn’t give that scenario more than 20% probability. Similarly, we would only assign 20% or less probability that the BoC eases or the Fed hikes in October. Either event would probably push USDCAD to about 1.38,” say BMO.
If these forecasts do play out then October promises to be an exciting month for CAD watchers with the bias for weakness being apparent.
