Fundamental Forecast for Canadian Dollar: Bearish

- Headline Canadian retail sales disappoint; but it is the core figure that truly weighs growth expectations
- USDCAD’s rally has begun to flag; but candlestick analysis shows a lack of conviction in the reversal

The Canadian dollar has recovered through the end of this past week; but the single currency has nonetheless been pushed to the brink of a major reversal. The loonie (a common moniker for the currency) actually dropped against all of major counterparts over the entire week; and the pain not end there. Three to six months ago, the Canadian dollar was advancing under its own power as growth and interest rate forecasts pegged a potential return on the nation’s assets that would easily outpace most of its counterparts – and most importantly, its US equivalents. In more recent weeks and months, however, we have seen this potential completely diminish. And yet, the currency is still maintaining extraordinary highs against the likes of the greenback, the euro and pound. Will the market come to this realization of inequity and reassess the loonie’s value?

There are two prominent fundamental pillars that have kept the Canadian dollar elevated – whether they are justified or not. The outlook for growth and interests over the second half of the year and beyond are essential to the currency’s buoyancy. Growth will be the top concern over the coming week. Printing its second quarter GDP reading late in comparison to its G7 peers, the government is expected to report a cooling of the 6.1 percent annualized pace of expansion in the first quarter to a 2.5 percent clip in the first. Though there has been a similar downshift for the US, such a development could further separate Canada from the Australian ideal (Australia will actually report its own growth reading over the same week) and draw expectations back down to reality. An inline figure would breakup groundless optimism on its own; but a disappointment would go much further in undermining already fragile risk appetite.

The other pillar for the Canadian dollar may not have a tangible catalyst next week; but it will nonetheless keep the currency on its toes. Interest rate expectations measured through Credit Suisse’s overnight index swaps are pricing in approximately 41 basis points of hikes over the coming 12 months (which translates into a certainty of a quarter point percent hike and debate over a second). This is a dramatic change from where forecasts were just six months ago. Nonetheless, bulls may still be holding out with economists forecasting a hike to the benchmark to 1.00 percent at the September 8th meeting with market participants pricing in a 56 percent probability of the same. If growth and interest rate potential deteriorate in succession, the Canadian dollar could be in for an extended decline from an overextended position.

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