Fundamental Forecast for Canadian Dollar: Neutral

- Bank of Canada Turns Cautious
- Canadian Price Growth Weakens in May
- Retail Spending Falters, Weighing on Growth Outlook
- USD/CAD: Bulls Return to Challenge Channel Top

The Canadian dollar lost ground against the greenback following a shift in market sentiment and the drop in risk appetite may drag on the exchange rate over the following week, while a slower pace of growth in Canada could discourage expectations for another rate hike as the central bank maintains a cautious outlook for the region. At the same time, with the G20 summit kicking off in Toronto over the weekend, comments from policy makers could weigh on investor confidence as the group turns its focus to the global imbalances and aims to bring about financial reform in an effort to support the world economy.

The Bank of Canada said “worldwide fiscal strains have the potential to cause tensions in interbank funding markets, to derail the global economic recovery, or to trigger a disorderly resolution of global imbalances” in its Financial Stability Review, and warned world policy makers may turn increasingly reluctant to implement global reform “either because of complacency as economic and financial conditions improve or because of fears that reforms could harm a still-fragile recovery.” At the same time, the BoC noted commercial banks could face greater difficulty in obtaining short-term capital as the global financial system remains under pressure, and went onto say that the rise in household debt remains an “important source of risk” as the economic outlook remains clouded with uncertainties. In addition, Governor Mark Carney pledged to watch the country’s exchange rate “closely” during an interview with Reuters as the marked appreciation in the Canadian currency hampers to prospects for future growth, and the central bank may look to keep rates on hold at its July policy meeting in order to support the economic recovery. Nevertheless, investors are pricing an 80% chance for a 25bp rate hike next month according to Credit Suisse overnight index swaps as the BoC looks to normalize monetary policy further in the second-half of the year, but we may see the central bank surprise the markets as the expansion in growth and inflation tapers off.

The economic docket for the following week is expected to show GDP expanding 0.2% in April after climbing 0.6% in the previous month, while factor prices are forecasted to rise 0.1% in May following a 0.3% advance in the month prior, and the slower pace of growth could drag on interest rate expectations as Governor Carney states that nothing is “preordained” for future policy. However, as risk trends continue to drive price action in the foreign exchange market, and rebound in market sentiment could lead the Canadian dollar to retrace the short-term decline and push the USD/CAD towards the 100-Day SMA at 1.0300 to test for short-term support.

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