Fundamental Forecast for Canadian Dollar: Neutral

- Canada Becomes the First G-7 Member to Raise Interest Rates
- Canadian Dollar Forecast Calls for Gains

The Canadian dollar looks to have gained some ground against the U.S. dollar, finishing as the second best performing G-10 currencies through Friday’s close, with the loonie likely to continue to lose ground against the greenback as price action stalls at the 100-day SMA for support. Indeed, the Bank of Canada recently hiked rates twenty five basis points to 0.50 percent in May from .025 percent the previous month after maintaining the lending rate near zero for more than a year. The increase comes to no surprise as Governor Mark Carney recently decided to drop the “conditional commitment” to keep rates unchanged until July, however market participants kept a close eye on the central bank’s comments that followed.

After announcing rates, the BoC said that further moves will be “weighed carefully” against future growth in Canada and elsewhere, and went onto add that “the decision still leaves considerable monetary stimulus in place, consistent with achieving the 2 percent inflation target in light of the significant excess supply in Canada. Nonetheless, policy makers stated that they will keep a close eye on further contagion from Europe’s crisis onto the financial markets as turmoil in the 16 member euro area is likely to result in higher borrowing costs and additional fiscal tightening for indebted countries. Away from the rate decision, the previous week’s data also showed that economic activity expanded the most in a decade. Moreover, the unemployment rate for the loonie remained unchanged at 8.1 percent, while employers added 24.7K individuals to the workforce. The data bodes well for U.S.’s largest trading partner as the surge in full time employment, and the contraction in part time employment, illustrates that employers are retaining workers, while previous discouraged workers re-enter the labor force amid an improved outlook for employment growth.

Looking ahead to this week, the economic docket is fairly quiet for the loonie as CAD traders await the new housing price index in April, which is expected to rise 0.3 percent, while housing starts are surveyed to rise to 205.0K in May from a downward revision of 200.7K in April. Meanwhile, international merchandise trade is forecasted to rise 0.7B in April from 0.3B the previous month. With regards to rates, investors are pricing in a sixty four percent chance that the policy makers in Canada will hike rates another twenty five basis points at its next rate decision on July 20th, 2010 as the domestic economy continues to charge ahead. However, traders should not overlook policy makers pausing rates this month as European woes continue to rattle the markets. As of late, Fitch downgraded Spain’s long term foreign and local currency issue default ratings from “AAA” to “AA+,” while Hungary’s Prime Minister recently said that talk of a default is “not an exaggeration” due to the previous administration “manipulating” figures.

Indeed, spillover effects onto the loonie have thus far “been limited to a modest fall in commodity prices and some tightening in financial conditions” as the central bank pointed out. Thus, as the European crisis continues to weigh on the markets, I will take the contrary view from many economists and expect the BoC to hold rates this month. With regards to price action, we have recently seen the Canadian dollar give away against all major currencies expect for the high-yielding New Zealand and Australian dollars, and similar price action is likely to carry into next week’s trade. Specifically, the USD/CAD may continue its northern journey after the pair recently stalled at the 100-day SMA for support and slipped above the 200-day SMA, with a break above 1.06 exposing resistance at 1.07.

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