Outlook for Canadian Dollar Following BoC Sell-off: The Next Levels to Watch

Image © COSPV, Adobe Stock

- CAD in trouble after data and BOC stand-down

- GBP/CAD and USD/CAD pairs striking higher

- But, risk of pull-back or exhaustion for GBP/CAD

The Canadian Dollar suffered a sharp fall after the Bank of Canada (BOC) indicated on Wednesday they don’t see themselves raising base interest rates over coming months.

The expectation that interest rates could rise again in 2019 had been a major factor underpinning the Canadian Dollar since higher rates tend to attract and keep greater inflows of foreign capital.

"The Bank is still saying that current rates are below neutral, and refers to increased uncertainty about the timing of future rate increases (with no reference to any possibility of cuts) leaving a slightly hawish tilt in place," says Avery Shenfeld, chief economist at CIBC Capital Markets. "Market rates are lower in response and the Canadian Dollar is weaker, but it will be hard to get any follow-through given that we are not pricing in any rate hikes this year already, and there was no tilt yet towards a fully neutral stance."

The Pound-to-Canadian-Dollar rate went 0.78% higher to 1.7704 in the wake of the Bank of Canada policy event, and has now risen 1.75% in 2019, while the USD/CAD rate was quoted 0.69% higher at 1.3449 following the announcement but is still down by -1.09% this year.

"The BoC is effectively one step removed from throwing in the towel on the policy cycle. We now expect an extended pause that should last - at a minimum - throughout 2019. This is a bad omen for CAD, which has now become the problem child of the G10," says Mazen Issa, Senior FX Strategist with TD Securities.

But the Bank of Canada is not the only reason for the rise in USD/CAD - renewed Dollar strength also helped the pair. The greenback rebounded after the ISM Non-Manufacturing index showed a stronger-than-expected result in February.

This suggests the services sector of the U.S. economy is not in as bad shape as perhaps some economists had feared. The data contributed to USD/CAD rising.

From a technical perspective, the recovery simply continues the exchange rate’s slow grind higher from the September 2017 lows. It also appears to herald the start of a new short-term upswing after the exchange rate found a floor at the base of channel in the 1.30s in January, at the level of the 50 and 200-day (MA).

The expectation is that the pair will continue rising up to the top of its channel and reach the 1.37-38 level eventually.

The break higher from the base of the channel can be seen more clearly on the daily chart above. The pair actually formed an inverse head and shoulders reversal pattern at the lows and then broke above the neckline and surged higher.

Inverse H&S patterns are composed of three trough lows, the middle one of which - the head (H) –is the lowest, and the two either side - the shoulders (S) –are of a similar depth. The tops of the intervening peaks establish the neckline, a break above the neckline provides confirmation of a breakout higher.

Inverse H&S’s tend to move the same distance higher as their height from the trough low of the head to the neckline. This suggests an upside target at circa 1.3580.

This is not that far from the 1.3515 target suggested by strategists at the global investment banking arm of Westpac in a recent strategy note in which they urged investors to hold their USD/CAD long positions.

“Risks are building for a more sustained topside breakout and so we extend the trade another week, tightening our parameters to an in-the-money stop at 1.3240 and a fresh target at 1.3515,” says Richard Rennie, a foreign exchange strategist with Westpac.

Apart from expecting a dovish BOC (meaning not in favour of higher interest rates), Westpac also states a lower-than-expected GDP growth rate in Q4 of only 0.4% and rising political risks as contributing factors to a more negative outlook for CAD.

“Political risks seem to be increasing too; an ethics controversy has engulfed PM Trudeau resulting in three high-profile resignations including two cabinet ministers. The Huawei executive arrest is creating a testy relationship with China too,” says Rennie.

The ‘ethics controversy’ surrounding Trudeau is about whether he or his aids inappropriately pressured the Justice minister to drop a case against a national construction company SNC-Lavalin because of fears that it would cost thousands of jobs. SNC-Lavalin had been accused of bribing officials in Libya. In the end, a new law was used which meant it was only fined.

The controversy appears to be impacting on Trudeau’s popularity ahead of elections in October and comes after he broke the Parliamentary ethics code by accepting a free helicopter flight for him and his family from billionaire philanthropist Aghar Kahn.

Where Next for the Pound-Canadian Dollar Exchange Rate?

The outlook for the GBP/CAD pair is also bullish. It had broken above the top of a long-term range – or possibly rising channel - and this suggests substantially more upside to come, to a target at 1.8050.

Momentum is at overbought extremes, however, and this makes us cautious of adopting an overly bullish stance. It is possible there will be a pull-back from these extremes for both the indicator and GBP/CAD. It could well fall back down in what analysts call a ‘throwback’ move to the top of the range at around 1.77 before moving higher. Throwbacks are common phenomena after breakouts.

Another more bearish interpretation might suggest the breakout was actually an exhaustion move to the upside.

This is especially true if the range is viewed as a rising channel instead since breakouts to the upside of bullish channels are usually exhaustion moves which quickly reverse and start falling. If so, this would forecast a much deeper decline back inside the channel. Given continued high Brexit uncertainty this is possible.

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