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Canadian Dollar Rises but Analysts Stay Wary; Prefer to Sell on Rallies

-CAD rises Monday as US Dollar eases from recent highs.

-But respite to be short-lived amid White House trade war.

-USD/CAD to resume uptrend as trade conflict simmers. 

© Pavel Ignatov, Adobe Stock

The Canadian Dollar rose against many of its rivals Monday although respite from recent losses will be short-lived, according to multiple analysts, who advocate that clients continue to sell the currency against the US Dollar.

Monday's price action comes as the Canadian Dollar continues to enjoy a tailwind from last week's Bank of Canada (BoC) interest rate rise and as the US Dollar eases lower in the wake of several days worth of strong gains. 

Looking ahead, analysts are warning of renewed losses in the weeks ahead because it is only a matter of time before President Donald Trump's "trade war", which is a severe risk to the Loonie, returns to dominate the market's agenda once more. 

"Put simply – the market has priced in a premium to USD/CAD movements based on the current trade environment. Whether it’s between the US and China, the US and Germany or NAFTA, there are implications for the Canadian economy and the CAD by extension if the global trade outlook deteriorates," says Bipan Rai, a macro strategist at Toronto-based CIBC Capital Markets. "Our current tactical view is still to buy USD/CAD on dips – especially if the 1.3000 level gives way."

The White House is pursuing restrictive legislation to govern Chinese investments into the United States and recently ordered a range of tariffs be levied against imports of more than $250 billion in imports of Chinese goods. Trump has also placed tariffs on imports of steel and aluminium from China, Canada, Mexico and the European Union in an effort to reduce the US trade deficit.

The EU has since responded with its own levies on US motorcycles, jeans and whiskey, drawing threats of even more tariffs from the White House, this time targeting the mighty European automotive sector. Fears are that a tit-for-tat tariff fight between the world's largest economies will quickly descend into an all out "trade war" and that this will dent economic growth in all countries it touches.

Officials from the US Department of Commerce are to hold a public hearing on Thursday 19, July where companies will be able to make representations relating to a Section 232 Trade Expansion Act investigation into whether the current automotive industry landscape presents a threat to US national security. 

"USDCAD waffled around 1.3145 as we write as investors take a wait-and-see approach to the CAD. Eyes are on the US public hearing on the auto tariff which could launch the Americas into the next phase of the trade war in their side of the globe," says Saktiandi Supaat, head of FX research at Maybank. "We prefer to sell this pair on the upticks in the medium term."

The investigation is widely seen as a necessary precursor to the White House imposing tariffs on cars imported from Europe. Any move to target the car industry could have implications for Canada and the North American Free Trade Agreement (NAFTA) negotiations because Mexico is used as a manufacturing base by many European car firms who then ship their products across the border into the US. Canada is also popular with truck manufacturers. 

Presumably, for car tariffs to be effective against European car firms then they would also need to be levied on cars imported from Mexico, which raises questions about the future of the NAFTA pact. Only time will tell if they are although officials from all sides of the US border have been attempting to renegotiate the NAFTA deal without success for a year now.

This is noteworthy because analysts have previously estimated a US withdrawal from the pact could see the Canadian Dollar fall by 20%. However, NAFTA and President Trump's trade war are not the only weights around the ankles of the Canadian Dollar this summer, as Bank of Canada monetary policy is now an increasingly diminishing source of support for the currency. 

"Data momentum is running at the lowest level in the G10 while Canadian nowcasts point to lost steam. The result is that we look to buy into any USDCAD dips, looking to fade extremes in the 1.30 to 1.35," says Mark McCormick, North American head of FX strategy at TD Securities. "USDCAD sits near High Frequency Fair Value and positioning seems to be leaning short so rather than chase the move higher we will look to reestablish fresh longs as we approach the bottom-end of the range near 1.3050."

The Bank of Canada raised its interest rate by 25 basis points to 1.5% last week, marking a fourth increase of the cash rate in the last 12 months, although analysts are divided over the question of if and when it will raise rates again this year.

In order for markets to feel confident betting the BoC will raise rates again in the near future, momentum behind the Canadian economy will need to gather pace, but this may be unlikely given the extent to which the BoC believes the "trade war" threatens Canada's economy. 

"The Canadian dollar is lower, reflecting broad-based US dollar strength and concerns about trade actions. The possibility of more trade protectionism is the most important threat to global prospects," says Governor Stephen Poloz, in a statement last week. "Business investment is growing in response to solid demand growth and capacity pressures, although trade tensions are weighing on investment in some sectors."

Pricing in interest rate derivatives markets, which enable investors to protect themselves against changes in interest rates while providing insight into monetary policy, implies a Canadian cash rate of 1.74% on January 16, 2019, which is below the 1.75% rate that would prevail if the BoC raised rates again.

This suggests markets are not yet completely convinced another interest rate rise will come this side of the New Year. however, there is a silver lining in this particular cloud. This is that if markets were to become more optimistic about the prospect of another rate rise in 2018, the Canadian Dollar could receive a powerful boost.

In this regard, Friday's inflation and retail sales data for June will be watched closely by traders.

The USD/CAD rate was quoted 0.17% lower at 1.3134 Monday but is up by 4.4% in 2018 while the Pound-to-Canadian-Dollar was 0.03% lower at 1.7370 but has risen 2.6%.

 

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