Fundamental Forecast for Canadian Dollar: Bullish

The Canadian dollar lost ground as economic activity unexpectedly weakened in May, but the loonie may regain its footing in the week ahead as growth prospects improve. Employment in Canada is anticipated to increase another 15.0K in July after expanding 28.4K in the previous month, while business spending is expected to increase at a faster pace as market participants forecast the Ivey PMI to widen to 61.2 from 59.9 in June.

As private sector activity picks up, the fundamental developments may encourage the Bank of Canada to drop its balance tone for monetary policy, but the softer pace of price growth paired with the contraction in GDP could lead the central bank to maintain its wait-and-see approach throughout the second-half of the year. Governor Mark Carney has held a cautious outlook for the region as he sees an increased number of headwinds hitting the economy, and the central bank head may continue to talk down speculation for higher interest rates as fundamental outlook remains clouded with high uncertainties. In light of the recent comments by Mr. Carney, it seems as though the BoC will carry the 1.00% interest rate into the following year even as the central bank projects the economy to reach full capacity by the middle of 2012, and the near-term rally in the Canadian dollar may continue to give back the advance from earlier this month as rate expectations falter. According to Credit Suisse overnight index swaps, market participants now see borrowing costs increasing by less than 50bp over the next 12-months, which compares with bets for nearly 75bp worth of rate hikes just earlier this month, and the rebound in the USD/CAD may gather pace in the following month as the pair appears to have carved out a bottom in July.

Indeed, the rebound in the relative strength index suggests the USD/CAD will continue to retrace the decline from 0.9897, and we may see the exchange rate make another run at the 200-Day moving average at 0.9829 should the event risks scheduled for the following week fall short of market expectations. On the other hand, better-than-expected results could spark a sharp decline in the dollar-loonie, and the pair may fall back towards 0.9400 as growth in Canada outpaces the recovery in the world’s largest economy.

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