Fundamental Forecast for Canadian Dollar: Bearish

The Canadian dollar was mixed on the week as it gained against most of the majors outside the greenback and British pound. A strong Ivey PMI manufacturing report eased concerns that the export driven economy could see a sharp decrease in growth as demand from abroad waned. The sector showed strong hiring which offset the weaker than expected employment numbers form the week prior. However, the BoC left their benchmark rate unchanged as they expressed concerns over the global picture and its impact on domestic growth. The “loonie’s relative strength was surprising giving the dovish comments from policy makers. Nevertheless, the com-dollar lost ground against the greenback on the declining yield expectations.

The central bank expects that growth in the second half of 2010 will be slower than expected as the economy still has significant slack and net exports were weaker than it projected. Policy makers expressed concern that the sovereign debt risks that have surfaced in Europe could renew market strains, increasing risks to the global recovery. However, the current domestic picture remains bright despite the building risks as household spending was stronger than expected and there remains considerable monetary stimulus. Yet, the BoC’s financial assessment report showed that Canadians are taking on high levels of debt and are increasing their risks to another shock. Additionally, the central bank stated that “the probability of an adverse labor market shock materializing is judged to have edged higher in recent months.” Therefore, expect policy makers to remain cautious and remain on hold through at least the beginning of next year.

The upcoming economic docket is very light with only second tier releases scheduled which should leave price action at the mercy of broader trends. Chinese and U.S. fundamentals will offer the biggest event risk for the com-dollar as they will impact global trends and crude which is currently holding a 78% correlation with the USD/CAD. China’s inflation report is expected to show price growth of 5.0% which will increase the probability that the PBOC will hike rates. Tightening from the Asian central bank could weigh on commodity prices and the loonie as the global growth picture dims. Meanwhile, the FOMC will meet to decide future monetary policy, where they could potentially hint at further QE efforts beyond their recently announced $600 billion. The prospect of more pump priming could sink the greenback across the board with the potential stimulus sparking risk aversion and demand for commodities.

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