Canadian Dollar Supported as Traders Eye BoC Rate Hike but NAFTA Saga to Drag On

-CAD rises on continued tailwind from July jobs report.

-Robust economy supports wagers of Sept BoC rate hike. 

-But GDP data released in August, and NAFTA, are both risks.

© COSPV, Adobe Stock

The Canadian Dollar rose Monday as traders maintained a steady bid for the currency in the wake of Friday's stellar July jobs report, which has raised the odds of another Bank of Canada interest rate rise in the weeks ahead, even as the NAFTA negotiations took another acrimonious turn. 

Canada's Dollar rose against most of its developed world rivals Monday although notably, not the Japanese Yen and Swiss Franc, which are both so called safe-haven currencies, or the bombed-out New Zealand Dollar. It traded within a tight range against the US greenback, up for much of the session before declining to a fractional loss at the London close.  

This is after official data showed Canada's economy created 54,100 new jobs during July, up from a 31,800 gain in June, which was a country mile ahead of the consensus for jobs growth of just 17,000. 

That pushed the unemployment back to a post-crisis low of 5.8% in July, leading analysts to conclude the Bank of Canada's September meeting is now "live" for a potential rate hike. 

"The CAD should continue to outperform its dollar bloc peers as BOC tightening continues to be priced-in. Against the USD however, the CAD is over-loved and could be vulnerable to an extended USD lift off the back of EUR capitulation," says Mazen Issa, a currency strategist at Toronto-headquartered TD Securities. 

Sentiment toward the Canadian currency has improved in recent weeks, particularly after official data showed economic growth surging in May and exports rising at a rapid clip during June, placing the economy on track to deliver a solid performance for the second-quarter.

This is significant for currency markets because it is seen making a third 2018 interest rate rise from the Bank of Canada more likely, when just a few short weeks ago, analysts and economists were sceptical about whether the BoC would manage another hike this side of the New Year. 

However, TD's Issa is growing uneasy about the newfound optimism surrounding the Canadian Dollar, particularly as there is still a GDP report for the month of June that is due to be released ahead of the next BoC meeting. A poor June growth number might be enough to deter the BoC from a September hike, which would deal the Loonie a severe blow.

"Our concern is that the break to new [Dollar Index] highs along with the Emerging Market rout/Euro capitulation poses a risk for USDCAD in the coming weeks. The CAD has been a well populated long and we think failure to hold 1.32 resistance (daily downtrend) in USDCAD will trigger an accelerated topside move. Disappointment on the data front - GDP later this month especially - could prove nasty," Issa writes, in a note Monday. 

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

The USD/CAD rate was quoted 0.06% higher at 1.3147 around the London close Monday while the Pound-to-Canadian-Dollar rate was 0.24% higher at 1.6748. 

"The NAFTA negotiations remain the main issue but nothing will happen on that front over the summer recess. As a result there is no reason at present why the loonie should lose ground against the dollar in a major way," says Antje Praefcke, an analyst at Commerzbank.

Just like the market at large, Praefcke forecasts the Bank of Canada will raise its interest rate once more before the year is out. The Commerzbank team are forecasting the USD/CAD rate will finish the year at 1.30, around its current level, while Praefcke sees no reason for a sudden bout of Canadian Dollar weakness. 

However, and while the Loonie may not be due any sharp falls this summer, one thing that does look to be for certain is that the North American Free Trade Agreement negotiations will drag on for quite some time. And they may eventually not be resolved in such an amicable manner after all. 

Deal with Mexico is coming along nicely. Autoworkers and farmers must be taken care of or there will be no deal. New President of Mexico has been an absolute gentleman. Canada must wait. Their Tariffs and Trade Barriers are far too high. Will tax cars if we can’t make a deal!

— Donald J. Trump (@realDonaldTrump) August 10, 2018

Canadian foreign minister Chrystia Freeland was excluded from the latest round of NAFTA talks as US officials sought to make headway in the negotiations with just their newly-minted Mexican counterparts.

This first raised the spectre of Canada being sidelined from any new deal with Mexico, which would mean it has little choice but to seek a bilateral deal with the US, although President Donald Trump's tweets at the weekend appeared to suggest this sidelined position is now a reality. 

Negotiators from all sides of North American borders have been attempting without success to renegotiate NAFTA, which facilitates tariff-free trade between its signatories, for more than a year now ever since President Trump threatened to withdraw from it unless terms more palatable to the US administration can be agreed.

"Canada’s foreign affairs minister may be upbeat on recent NAFTA trade talks, but there are growing risks that an agreement just between the US and Mexico could leave Canada out in the cold," says James Knightley, chief international economist at ING Group. "Our FX team believes that the risks from any negative talk on a trilateral Nafta agreement will keep USD/CAD above 1.30 – and we’d need to see positive NAFTA news, or a surge in the stability of the US trading environment, in order to see a USD/CAD move below 1.30."

TD Securities analysts previously estimated a US withdrawal from NAFTA could see the Canadian Dollar fall by 20% as markets would be forced to mark down their expectations for Canadian economic growth and interest rates over the longer term. The USD/CAD rate is already 4% higher thus far in 2018.

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