Canadian Dollar Hits Six-month High after NAFTA Deal Gives Green Light to the BoC

© Shealah Craighead, The White House

The Canadian Dollar hit a six-month high Monday after negotiators clinched a deal to save the North American Free Trade Agreement (NAFTA) late on Sunday, but analysts say further gains for the currency are likely to be limited. 

NAFTA will now become the United-Statest-Mexico-Canada Trade Agreement after U.S. and Canadian officials broke an earlier deadlock over dispute resolution and access by U.S. companies to Canada's protected dairy market. 

Text of the new deal will now sit before the U.S. Congress for a 60 day period before being signed by the parties and then brought into force.

The deal removes a Damocles Sword from above the head of the Loonie and now gives the Bank of Canada (BoC) a green light to go on with its push to gradually raise Canadian interest rates. 

Toronto-headquartered TD Securities said in January a U.S. withdrawal would lead to a 20% fall in the value of the Loonie as markets would be forced to mark down their assumptions about longer term economic growth and interest rates.

"We expect that the CAD should rally as whatever NAFTA premium that is priced in is removed. Price action in USD/CAD has already gapped lower to start the week with support at the 1.2900 removed. This sets up a potential test of the 1.2744/5 mark, but the real test is at the weekly long-term trend line which currently comes in just above the 1.2600 handle," says Bipan Rai, a macro strategist at Toronto-headquartered CIBC Capital Markets. 

Sunday's deal preserves the Chapter 19 dispute resolution mechanism that empowers an independent panel to resolve problems involving a government of one of the pact's signatories in a binding manner. President Donald Trump had sought to remove this while the Canadians had pushed for it to remain in the agreement. 

The agreement will also provide U.S. farmers with more access to the Canadian dairy market, which receives subsidies from the Canadian government and is protected by tariffs levied on imports of foreign dairy products. Trump had sought to remove tariffs and address the susidy system. 

"However, even with the new deal, we suspect that there will be lots of interest to buy on USD/CAD dips over the medium-term," says Rai. "Put simply, we don’t envision a rush of additional investment into Canada at this time. Given that, we still see USD/CAD risks as asymmetric and favouring the topside."

Rai says Canadian households are carrying more debt than their U.S. counterparts and the nation's economy is less competitive than that of its southern rival in the wake of President Trump's tax cuts. This means the Bank of Canada will not be able to raise its interest rate as high as the Federal Reserve and justifies a higher USC/CAD rate over the long term.

The Bank of Canada is widely expected to raise its interest rate from 1.5% to 1.75% on Wednesday 24 October, with pricing in interest rate derivatives markets implying a near-90% probability the BoC announces a rate hike by then. 

The USD/CAD rate was quoted 0.65% lower at 1.2816 during early trading Monday, close to a six-month low, after whittling a near-4% 2018 gain down to just 1.8% overnight. The Pound-to-Canadian-Dollar rate was 0.51% lower at 1.6709 and is up just 1.34% this year. The Loonie was higher against all other G10 currencies for the session.

"GBP/CAD has now finally broken out of volatile broadening formation, and this indicates a bias to more downside in the short-term. The pattern consists of an ever-widening sequence of component waves and leads to a 'loudspeaker-like' appearance as shown on the 4hr chart below," says Joaquin Montfort, Pound Sterling Live's in-house technical analyst. 

Above: GBP/CAD rate shown at 4-hour intervals and including technical analysis. 

"The pair is now likely to fall an equal distance, or 61.8% percentage of the height of the broadening pattern at its widest point (a) extrapolated lower from the break (b).The full 100% extrapolation gives a downside target of 1.6445 whilst the more conservative 61.8% extrapolation gives a target at 1.6590," Montfort adds. "The key August lows are at 1.6600, which is another potential target as the pair is likely to pause at that point for a 'breather'."

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