In my view, the Canadian dollar is set for further gains. Here is why.
Strong data from Canada. On the employment side, numbers came very robust, 175k net change in employment, way above forecasts. Participation rate moved 0.4% higher and unemployment rate remained stable despite the rise in participation rate. Average hourly earnings also increased to 1.7%. year on year.
The Ivey PMI (measures the activity level of purchasing managers in Canada) a key indicator of the overall economic conditions shown significant increase. Latest retail sales, trade balance and GDP releases all came above expectations.
Market Correlations and Yields
The Canadian dollar is highly sensitive/correlated to oil and natural gas prices, as Canada is a big producer of both. Hence its economy is influenced by fluctuations in their prices. Higher oil and natural gas prices usually help the Canadian dollar and push the USDCAD lower.
I have plotted the natural gas, oil and Canada/U.S 2-year bond yield differential on chart. Along with the CADUSD( NOT USDCAD, just to illustrate the positive correlation).
Recently, the price of both commodities has been trending higher, recoding new highs. Yet the cad didn’t catch up until the past few weeks, and with a relatively smaller magnitude. This lag in cad price movement might be an opportunity to get long as the price play catchup.
The yield differential also support the cad side as the spread rises in favor of Canadian bonds.
Having that said, I see the USDCAD heading lower. My concern now should I buy the CAD against the dollar or euro? or maybe both to mitigate the risk of failure.
Latest fomc monetary policy statement published Sep 22 had some key changes.
July 28 statement
“The sectors most adversely affected by the pandemic have shown improvement but have not fully recovered. Inflation has risen”
Replaced with in sept 22 statement:
“The sectors most adversely affected by the pandemic have improved in recent months, but the rise in COVID-19 cases has slowed their recovery. Inflation is elevated”
Another key line is the following
“Since then, the economy has made progress toward these goals, and the Committee will continue to assess progress in coming meetings”
Replaced with in sept 22 statement:
“Since then, the economy has made progress toward these goals. If progress continues broadly as expected the Committee judges that a moderation in the pace of asset purchases may soon be warranted.”
The bank language has changed in terms of inflation and the asset purchase program(bolded text). FED is close to start tapering the asset purchases(Tapering is a gradual slowing of the pace of the Fed’s asset purchases).
The fomc economic projections (below image) explains their outlook. I have highlighted the most important changes between June and September projections.
While this news is 20 days old, it is significant. The central bank bias is now toward tightening(hawkish). Lifting interest rate by 20bps next year along with mentioning reduction of asset purchases (tapering) soon may continue to support the USD. And thus support the CAD(since both economics are highly correlated) against the euro.
Having that said, I am slightly bullish the USD but not against CAD.
The ECB continues to maintain its dovish bias. The minor change mentioned in its latest statement was “a moderate decrease in the pandemic emergency purchase program (PEPP)”. Reducing the pace of emergency support doesn’t change the overall monetary easy bias.
Meanwhile, the central bank expects the inflation to overshoot its target in the short term(2021), it considers the rise due to transient factors and expect inflation to move back well below its target of 2% in 2022.
Recent data for the eurozone were at best mediocre. Key indicators of retail sales, services and manufacturing indices disappointed.
Europe/US Yields Differential
The chart above plots the 2-year bond yield differential(spread) between Germany(a standard proxy for the European union) and the U.S.
– They differential chart is plotted by subtracting the German yield from the U.S yield. – – As yield rises more rapidly in the U.S compared to Germany the yield differential widens.
– A higher yield is more attractive for the currency compared to a currency with lower yield.
The spread has been falling recently(German yields underperforming U.S yield), yet the EURUSD have risen in the past few days. This divergence might be due temporarily factors(the latest U.S employment report) given that the overall picture remains fairly unchanged.
Having that said, I continue to be bearish the euro.
The Trade Setups
Despite my view that the U.S fundamentals may support the USD against some currencies, the Canadian dollar my outperform the USD according to the reasons I mentioned above. Does the technical picture confirm this bias?
A major topping pattern completed on the USDCAD chart. The price have completed a head and shoulders top by breaking its neckline as clear on chart. The 200-days and the 1.2493 major swing low were also broken last week.
I am looking for a minimum target at next swing low near 1.2250. More than 200 pips from here.
EUR short is my main pick as explained above. Technically speaking, the price has completed a symmetrical triangle pattern just below the 200-days moving average. The breakout below the triangle support was followed by a break of latest main swing low at 1.4582.
I would short any upside pullback, targeting the next key swing low at 1.4263 as a minimum target.