The Canadian Dollar is on Course for Further Gains Now NAFTA Uncertainty is a Thing of the Past

Image © Bank of Canada

The Canadian Dollar remains on the front foot and is on course for further gains, according to analysts covering the currency, some of whom have taken losses and walked away from previous bearish bets against the Loonie. 

Canada's Dollar has risen close to 2% against the U.S. Dollar and other rivals since the Asian open Sunday night, after it emerged the Canadian government has struck a deal with President Donald Trump that preserves the North American Free Trade Agreement (NAFTA), albeit under the new U.S.-Mexico-Canada-Free-Trade-Agreement (USMCA) monika. 

"We close our USDCAD long in our FX Model Portfolio after our stop-loss was triggered for a ~1.8% loss," says Mazen Issa, an FX strategist at Toronto-headquartered TD Securities. "We initiated this trade in early summer on the basis that the BOC curve was well-priced, CAD data momentum would soften, and NAFTA relations would be strained. Now with less trade uncertainty, the CAD could recalibrate to other drivers for the time being."

Saving the NAFTA pact, which President Trump threatened to tear up if he could not renegotiate it, was key for the Canadian Dollar outlook because analysts and economists said the Loonie would suffer as a result of slower economic growth and lower interest rates over the longer term if the North American free trade area was alllowed to disintegrate. 

The Canadian Dollar had wracked up losses against most of its rivals for the year-to-date given previously-mounting fears that the deal could not be preserved, given U.S. belligerance toward the leadership on the opposite side of its northern border and Canadian intransigence over the White House's earlier concerns with the old deal. 

"CAD is strong," says Shaun Osborne, chief currency strategist at Toronto-headquartered Scotiabank. "Domestic rate expectations are firm with OIS pricing roughly one full 25bpt BoC rate hike for October and another 20bpts by January. Yield spreads are narrowing in a CAD-supportive manner and measures of sentiment are delivering added support. Net short speculative positioning leaves CAD vulnerable to additional near-term strength."

The USD/CAD rate was quoted 0.10% higher at 1.2822 Tuesday, close to a six-month low, after whittling a near-4% 2018 gain down to just 1.8% since Sunday.

The Pound-to-Canadian-Dollar rate was 0.57% lower at 1.6616 and is now down 1.9% for 2018 after more than reversing an earlier 1.34% gain. 

"USDCAD is testing fresh four month lows under 1.2800 following its break through the lower bound of the descending trend channel from June. Technical signals are broadly bearish and additional nearterm support appears limited ahead of the May lows in the mid/lower-1.27s," says Eric Theoret, a Scotiabank colleague of Osborne's, in a note Monday. 

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.

"The break below the 200-dma in USDCAD may help keep the pair heavy, though the extent of this may be limited. We would be a bit surprised to see a move below key support near 1.2700/30 given that CAD longs has been well established on the crosses (less so vs. the USD however). Tightening in the curve is also more than sufficient at this point, and we do not expect the current deal will do much to shape policy in the near-term," says TD's Issa. 

The Bank of Canada (BoC) 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. 

Pricing in interest rate derivatives markets, which enable investors to protect themselves against changes in interest rates while providing insight into monetary policy, has shifted in favour of more interest rate rises from the BoC over coming months since the new NAFTA deal was unveiled. 

The market implied interest rate for the BoC's October 24 meeting was 1.71% on Tuesday, up from just 1.64% at the beginning of September, while the rate implied for January 09 has moved from 1.84% to 1.97% during the same time. 

"The Bank is very clearly going to treat these developments as positive relative to their baseline scenario, and as such it will lower the hurdle to follow up hikes in 2019," says TD's Issa. "While the market might try to push the long CAD story, we think its scope to rally further is limited. Beyond a positioning squeeze, we think USDCAD should continue to maintain the 1.28/1.32 range." 

Advertisement
Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here