Fundamental Forecast for Canadian Dollar: Bearish

The Canadian dollar continues to track the trends in financial markets’ risk appetite. Indeed, the inverse correlation between USDCAD and the MSCI World Stock Index – a proxy for underlying sentiment – now stands at the strongest in two weeks (-0.66). Looking ahead, this hints the path of least resistance leads lower as a confluence of headwinds bears down on the spectrum of risk-sensitive assets.

The bears have their pick of reasons to push prices lower. Turmoil in the Middle East and North Africa continues, with Libya now engulfed in all-out civil war and protests heating up in Yemen, Bahrain and – perhaps most dangerously with regard to oil prices – Saudi Arabia. Further, signs of material economic slowdown are becoming increasingly apparent in China following a dismal trade balance report. Finally, the end-game to the Euro Zone debt crisis appears to have been fumbled even before the crucial March 25 sit-down of the region’s leaders as a preliminary summit on Friday yielded an agreement conspicuously heavy on rhetoric but short on substance, opening the door for sovereign default fears to swell anew.

Policymakers announced changes that were largely ceremonial: the European Financial Stability Facility (EFSF) will now be able to access its full capital base of 440 billion euros, and set “goals” rather than binding targets on budget rules for member states. These are half-measures at best: the bailout fund is still woefully inadequate to deal with the rescue of a larger state like Spain, and Euro Area members’ past record on adherence to the Stability and Growth Pact (which outlines budget deficit limits) suggests the new benchmarks will not amount to much in practice.

On the economic data front, the focus remains on US releases as the fate of Canadian growth continues to be firmly anchored to that of its northern neighbor. Sizing up the docket, all eyes are surely focused on the Federal Reserve monetary policy announcement, with progress in policymakers’ cautious move toward a more optimistic-sounding posture promising to bolster the Loonie amid expectations of firming recovery in its top trading partner. This may prove to offset some risk-driven losses but seems unlikely to altogether negate them, hinting the Canadian unit may outperform, but only in that it slides less than other risk-geared currencies against the safe-haven camp of assets.

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