Fundamental Forecast for Canadian Dollar: Neutral

The Canadian dollar pushed higher against its U.S. namesake last week, climbing some 0.41 percent. Indeed, the advance in the loonie marks the four successive week that the currency rallied against the greenback; however, the gain in the Canadian dollar may be short-lived as focus shifts to the Bank of Canada interest rate decision. Furthermore, crude oil’s failure to break above 92.60 after testing the level for a third time this past week is hinting at a slight correction.

During this past week, the dismal economic releases in Canada failed to ease strength in loonie against the buck as risk appetite weighed on the greenback. Taking a look at the recent developments, Canadian building permits disappointed in November as figures dropped 11.2 percent amid economics’ estimates of a 1.5 percent increase, while housing starts fell to 171.5K in December from a revised 198.2K the month prior. With regards to the former, because of the high outlays needed for construction projects, the reading suggests lower consumer and corporate optimism. Not to overlook, traders also shrugged off Canada’s trade deficit which narrowed in November amid a decline in energy imports. Though markets dismissed the data, the release is worrisome due to the fact that Canada relies on exports and the report showed the largest decline in purchases from overseas since March 2009. These developments combined with consumer prices which recently slowed to 2.0 percent in November will lead the Bank of Canada to refrain from raising its key overnight lending rate.

As of late, traders are pricing in a four percent chance that the BoC will hike rates twenty five basis points at its rate decision meeting on January 18th. At last month’s meeting, the central bank kept its overnight lending rate unchanged amid uncertainty surrounding its economic outlook and a strong Canadian dollar which may weigh on growth as U.S. which is Canada’s key trading partner continues to battle tight credit conditions, a high unemployment rate and subdued wage growth. At the same time, a strong loonie could widen the trade imbalance even further. Though Canada’s international ties are worrisome in these market conditions, policy makers last month were not as concerned as many economists surrounding the Euro-zone troubles. I expect the central bank to remain optimistic about growth in the 17 member euro area following the recent bond auction in the bloc. All in all, the Bank of Canada is widely expected to hold its key benchmark interest rate at 1.00 percent; however, comments following the rate decision will likely dictate price action and a slightly more dovish statement will surely add weight onto the loonie. Also on tap will be the leading indicators and retail sales reports.

Taking a look at price action, the pair continues to trade in a descending channel on the daily chart. Indeed, the price action provided a false breakout on the hourly chart, but as daily studies enter oversold levels, traders should not rule out a reverse in course. It is also worth noting that our speculative sentiment index stands at 6.65 and signals for additional losses in the near term.

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