Fundamental Forecast for Canadian Dollar: Bearish

The Canadian dollar extended the rally from the end of October, with the USD/CAD falling back below parity, and the exchange rate may continue to push lower over the following week as it maintains the downward trending channel carried over from the previous year. However, as the USD/CAD approaches the lower bounds of its range, there could be a short-term reversal following the sharp decline over the last two-weeks, and the dollar-loonie may trade within wide range going into the end of the year as price action holds above the 78.6% Fibonacci retracement from the 2007 low to the 2009 high around 0.9900-20.

With the economic docket expected to reinforce a weakened outlook for the Canadian economy, a batch of dismal data could spark a reversal in the exchange rate as investors weigh the prospects for future policy. Housing starts in Canada is forecasted to weaken to an annualized pace of 182.0K in October from 186.4K in the previous month, which would be the slowest pace of growth since December, while the trade deficit is projected to widen to CAD 1.6B in September from CAD 1.3B as the rebound in global trade tapers off. As the Bank of Canada embraces for a tepid recovery, with Governor Mark Carney holding a cautious outlook for the region, the slower pace of economic expansion could lead the central bank to maintain a wait-and-see approach in December as the prospects for future growth remains clouded with uncertainties. According to Credit Suisse overnight index swaps, investor are pricing only a 4% chance for a 25bp rate hike on December 7, and interest rate expectations could deteriorate in the weeks ahead as the central bank adopts a highly dovish tone for monetary policy.

If a USD/CAD reversal unfolds over the following week, the exchange rate should work its way back towards the top of its range, but price action may be confined by the 200-Day SMA at 1.0323 as the pair failed to close above the moving average in October. As a result, the dollar-loonie may trade within a 300 pip range throughout November as the central bank adopts a dovish tone, and interest rate expectations could play an increased role in driving future price action for the dollar-loonie as the BoC pledges to “carefully consider” any further tightening in monetary policy. At the same time, with the G20 Summit kicking off in South Korea next week, comments from global policy makers could spark increased volatility in the currency market, but we expect BoC Governor Carney to maintain a cautious outlook for Canada as he expects the economy to operate below full capacity until the end of 2012.

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