Fundamental Forecast for Canadian Dollar: Bearish

The Canadian dollar re-tested parity as emerging solutions for the credit crisis in Europe and strong manufacturing data in China and the U.S. fueled risk appetite. Loonie bulls shrugged off a weaker than expected 3Q GDP reading which showed the pace of growth slowing to 1.0% from 2.3% the period prior. The economy contracted in September as manufacturing fell 0.6% which was overshadowed by the broader growth in the sector. However, weaker than expected job growth in November adds to the declining growth picture and could cause the BoC to pause their tightening policy. The central bank’s upcoming policy meeting could determine short-term direction for the Canadian dollar as markets still see the potential for another rate hike, making the outcome uncertain.

Governor Carney in his latest remarks stated that the Loonie’s current valuation in relationship to the dollar is appropriate and is reflecting current fundamentals. The central bank in the past has expressed concern over the local dollar’s strength as it is discourages demand for exports. Therefore, we can’t rule out that the MPC will continue their tightening policy which has pushed the benchmark rate to 1.00%. Inflation rising to 2.4%also makes the case for additional tightening especially with the core reading reaching 1.8%. However, policy makers have been keenly aware of the dependence of their economy on demand from abroad and have consistently stated that global factors could trump domestic fundamentals when determining future policy.

Considering that the domestic picture has started to dim, the upcoming Ivey PMI manufacturing gauge will help shape the outlook for yields ahead of the BoC rate decision. Therefore, the indicator could cause short-term volatility but don’t expect significant follow through with the policy meeting to follow. The major event risk will be the rate decision but its impact on price action may be rooted in the post release remarks rather than the actual decision. A rate hike should generate short-term support unless we see Governor Carney hold a dovish tone and hint that the central bank will remain on hold for the foreseeable future. Conversely, a rate hold but concern over rising inflation and language that points to the possibility of future tightening could generate support. Meanwhile, no action and a diming prospect of future changes in monetary policy could sink the commodity dollar which would support current technicals. A short-term range with parity as the lower bound is pointing o upside potential for the USD/CAD which has inspired a long position.

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