Canadian Dollar Now Oversold but NAFTA Deadline is Approaching and Talk is Cheap

- USD/CAD is now "overbought", suggesting CAD may be oversold.

- NAFTA commentary and oil price rise are supportive of the Loonie.

- But with May 01 NAFTA deadline approaching, talk is cheap. 

© kasto, Adobe Stock

The Canadian Dollar has been oversold against the US Dollar during recent days and could be due a corrective rebound, according to strategists, although a key deadline for a North American Free Trade Agreement (NAFTA) deal is approaching and an agreement is far from certain.

Canada's unit is now considered to be in oversold territory despite having held up better against a US Dollar onslaught than many other developed world currencies this week. It has fallen 1.5% against the greenback in recent days and is relatively unchanged against a weak Sterling although we are told the longer-term outlook remains liable to further gains in GBP/CAD.

"The Canadian Dollar is the most resistant to gains with USD/CAD backing off 1.29. Steady oil prices, rising Canadian bond yield spreads and the prospect of a NAFTA deal have limited the slide in the loonie," says Kathy Lien, a managing director of foreign exchange strategy at BK Asset Management

Prices of crude oil, Canada's largest export, have risen during the last week with WTI crude rising 3.4% to $68.20 as fears over a supply crunch have mounted in tandem with concerns over US commitment to the international agreement on Iran's nuclear programme. 

Commentary from Bank of Canada governor Stephen Poloz has also proven supportive of the Loonie, with markets now looking toward the July meeting for a second 2018 interest rate rise.

"The economy is close enough to its potential that we’re in that space where it’s more a question of the timing and at what pace do interest rates move towards more normal levels,” Poloz told a committee of lawmakers on Wednesday.

The Bank of Canada jarred the Canadian Dollar last week when it held interest rates at 1.25% and said the recent increase in domestic inflation was mostly "transitory" and that the economy has scope to grow at a faster pace before inflationary pressures become a concern. 

"We believe the BoC is effectively keeping USDCAD in a “managed float” range between 1.20 and 1.35 – although the recent BoC meeting dovishness suggests the lower bound may have moved higher," says Shahab Jalinoos, an FX strategist at Credit Suisse. "Trade threats give reason for BoC to welcome FX weakness in shorter."

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"The CAD is unlikely to benefit fundamentally from a resumption of interest rate normalization at home, as this is largely already priced-in, but its still-to-be-exploited undervaluation and the prospect of a new NAFTA agreement ultimately put the “loonie dollar” at the top rank of our commodity FX universe," says Roberto Mialich, an FX strategist at UniCredit Bank.

Recent commentary had made investors question how many more times the BoC will raise rates during 2018. For now, markets are betting on just two more rate rises but this could change in the coming months if GDP growth picks back up from its first-quarter slowdown and negotiators reach and deal to preserve the North American Free Trade Agreement. 

“There is a very strong, very committed, good-faith effort for all three parties to work 24/7 on this and to try and reach an agreement,” Chrystia Freeland, Canada's foreign affairs minister, told reporters Wednesday after a meeting with US trade representative Robert Lighthizer.

Hopes that a deal can be reached before May 01 are still high, even if there remains a number of barriers to be overcome. The beginning of May is an important date for the Loonie because it coincides with the expiration of Canada's exemption from new US tariffs on aluminium and steel.

President Donald Trump has tied a permanent exemption from the new tariffs to a successful renegotiation of NAFTA and markets have been looking for an "agreement in principle" to be unveiled before May 01 in order for levies to be scrapped.

"There is optimism that an agreement can be reached in the next few days. If that were to be the case this would help CAD for two reasons: first of all the risk of the negotiations failing would obviously be avoided, and secondly the path would be clear for further Bank of Canada rate hikes," says Thu Lan Nguyen, an analyst at Commerzbank.

Not only that, campaigning for the July Mexican Presidential election is expected to prevent talks from continuing once into May and November's US midterm elections could frustrate talks after that. This means that if a substantial body of the deal is not negotiated in the coming days, a cloud of economic uncertainty could be left hanging over the Loonie until near year-end.

"Should an agreement not been reached by early next month, the negotiations are likely to be put on hold due to the Presidential elections in Mexico in the summer so that the uncertainty would continue which in turn might dampen the economic outlook," Nguyen adds.

This would further sour the outlook for Canadian interest rate rises and leave the currency vulnerable to more weakness relative to its developed world peers, particularly in the current environment where price action in the bond market is increasingly making itself heard in the currency world. 

Above: US 10 Year Government Bond Yield.

American 10 year bond yields topped 3% Wednesday, their highest level since the European debt crisis, and remained above this pivotal threshold on Thursday.

This is significant because it makes US bonds relatively more attractive than their developed world counterparts, which is positive for the Dollar because investors have to sell other currencies and buy the greenback in order to exploit these improved yields.

Should current trends in the bond market continue then, absent a breakthrough in efforts to renegotiate the NAFTA deal, the Canadian Dollar may find itself under continued pressure as the April month draws to a close. 

Above: USD/CAD rate shown at daily intervals.

The USD/CAD rate was quoted 0.10% higher at 1.2849 during the morning session in London Thursday. 

"USDCAD – Overbought - traded sideways and was last seen around 1.2840. CAD was the most resilient against the USD strength in overnight trade in the G10 space," says Saktiandi Supaat, an FX strategist at Maybank in Singapore. "Support at 1.2680."

The Pound-to-Canadian-Dollar rate was 0.01% higher at 1.7889.

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

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