US v Canadian Dollar Still a Sell on Spikes: BMO Capital

Canadian dollar outlook

The Canadian dollar may have seen its fortunes take a turn for the worse since the 3rd of May but rallies in USD/CAD should be sold argue BMO Capital. Greg Anderson, Global Head of FX Strategy writes:

Last week’s devastating fires in Alberta were not the primary factor behind the 2.8% decline in CAD.

The bigger stories behind that move were the risk-off USD rally and the 3.3% decline in Brent crude.

However, the fires were a factor.

Western Canada Select crude rose +0.6% for the week as the interruption of production made heavy Canadian crude relatively scarce compared to lighter grades.

Higher oil due to a supply disruption is not necessarily good for CAD, though.

The fires could disturb a month’s worth of oil sands production. How much can be recouped later is unclear.

BMO’s economists have marked down their forecast for Q2 GDP to 0.0% from a previous +1.5.

They have added 1.0% to Q3 under the assumption that some of that production can be recouped, but acknowledge this is a very fluid situation (see pgs 2-3 of 06May2016 Focus for more).

At this time, our economists don’t think this disaster will trigger a BoC rate cut, but OIS markets moved from pricing in 3bps of BoC hikes through the end of the year to pricing in 4bps of easing.

With that rate move, the 2Y swap rate differential moved 6bps against CAD, as shown in Figure 7.

Our rotating financial factor model has USDCAD fair value at 1.2755 as of Friday’s close.

Fair value rose 112 pips on the week, but the 1M trend in fair value is still down for now, so the model is still in a sell-on-spikes mode.

In fact, the model is still holding a short position for now.

If fair value were to continue to drift higher, the model’s fair value trend direction could shift by the end of this week.

The pair hasn’t traded above 1.3000 since 11-April, but we see a good chance that stops and barriers in the 1.3000 to 1.3050 range get tested this week.