Canadian Dollar Can't Handle an Interest Rate Cut Warn N.B.C

Pound Sterling Live's Canadian dollar forecasts and analysis at the start of what should be a key week for a currency that continues to be battered by domestic and global drivers.

The outlook of commodity currencies remains grim and policy is likely to be even more accommodative.

The CAD, in particular, is suffering. "The Canadian dollar is in a tailspin. Rarely has it tumbled so far so fast, and against so many currencies. The steepness of the CAD’s depreciation against the USD is without precedent – 33%or 3.5 standard deviations, in 24 months," says Stefan Marion at the National Bank of Canada (N.B.C).

Is the Canadian dollar out of whack with its fundamentals? "We think so. By our calculation, the CAD should have depreciated about 10 cents to the USD in recent months, not 25," says Marion.

There is a meeting of the Bank of Canada on Wednesday and according to those institutional analysts we follow the January meeting will constitute one of the most significant FX events of the week.

"Currency instability has become a concern, and we think the Bank of Canada must take note. For Canadian businesses, currency depreciation has already sent the price of machinery and equipment (73% of which is imported) to a new record high. This is bound to complicate Canada’s transition to a less energy-intensive economy," says Marion.

N.B.C say the Bank of Canada would be better to keep its powder dry this month and act, if need be, to protect the currency. In their opinion a cut should only be considered after the next federal budget when it will be better able to assess fiscal support to the economy.

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But - A Cut is Coming

Despite N.B.C's concern over the impact an interest rate cut would have, there are many analysts out there who see the axe being swung.

Bank of America Merrill Lynch are calling a BoC interest rate cut this week, a move that could push the USDCAD 2% higher as the cut is still only priced at a 50% chance.

"Despite the recent overshooting of oil-sensitivity currencies like the CAD, NOK we see scope for further weakness as their central banks ease policy further. We expect the BoC to deliver a 25bp rate cut this Wednesday," say Barclays in a foreign exchange briefing at the start of the week.

TD Securities agree a cut is likely, “the Bank of Canada is expected to cut its overnight rate to 0.25%. Since the October MPR, the economy has been tracking far below the Bank's expected 1.5% pace of growth for Q4.”

Oil Woes

There will also be an elevated focus on the oil market following the lifting of sanctions on Iran which could swamp the oil market to the tune of 500K more barrels of oil a day, as well as numerous oil reports from Opec, the U.S DOE and IEA.

TD Securities also see further downside for the Canadian dollar:

“We still see further USD/CAD upside to come as Iranian supply and an intra-OPEC price keep oil price risks on the downside.”

Other signs of weakness in the economy, include the recent Business Outlook Survey which indicated deteriorating hiring and investment intentions, reflecting weakness in the energy industry.

Nor has the weaker CAD helped push up inflation as BoC thought it might:

“The shock-absorbing effect of the CAD has not worked as the Bank expected and underlying inflationary pressures remain below 2% in the Bank's view,” say TD Securities.

Technical Forecasts

USD/CAD – “buy, buy.”

The US to Canadian dollar pair continues its relentless up-trend. "There has not been a down day for USD/CAD since the beginning of the year.  This is the longest stretch of strength for the currency pair since October 2008," observes Kathy Lien at BK Asset Management.

It broke above the R1 Monthly Pivot and has now gone to 1.45 where it has encountered resistance from the R2 Monthly Pivot, and has pulled back.

The measured move, which I have drawn on as an A-B-C pattern has completed since A now equals C, and this could be a sign the pair could be ready for a pull-back.

RSI is showing the pair is overbought on all timeframes.

Given overbought conditions and the completed measured move, I would urge caution to bulls, however, the overarching fact remains that the pair is in a strong up-trend.

On Balance Volume, for example is strengthening in line with the trend, showing conviction in the buying.
Ultimately a break above the 1.4550 level could well move all the way up to the 1.48s eventually, although any of the round numbers on the way are potential selling spots.

GBP/CAD – spike higher

The pound to Canadian dollar pair has moved higher after breaking out of a down-sloping consolidation and finding support at the 50-day MA.

It spiked up today (Friday), and reached just short of the R2 Monthly Pivot and previous highs at 2.0960, which constituted its next target higher.

Despite forming a bearish shooting candlestick which could indicate more downside, and the soft MACD and Volume, the up-trend still remains intact and likely to continue higher.

However, for confirmation of more upside, I would ideally wish to see a clear break above R2 - including a margin – so above 2.1020, with an initial target after that at 2.1100.