The Canadian Dollar Runs into Obstacle on Charts amid Speculation of Correction Lower

Image © Adobe Images

- BoC survey sees CAD collide with landmark resistance level.

- Survey suggests BoC unlikely to cut rates soon, supports CAD.

- But CAD lacks impetus to overcome major trendline, says TD.

- And stock market earnings suggest risk of correction lower.

- But medium-term outlook points USD/CAD below 1.30 level.

The Canadian Dollar softened Wednesday after an upbeat survey reading from the Bank of Canada (BoC) sent the currency head-on into a major resistance level on the charts in the prior session, which is being tipped as likely to produce a short-term correction lower by the Loonie. 

Canadian businesses still intended in the third quarter to hire new staff and invest in capital equipment at what the BoC says is a healthy rate, the latest Business Outlook Survey revealed on Tuesday, although the findings related only to non-energy producing regions. Companies continued to anticipate "moderate" sales growth and further increases in selling prices up ahead in the recent quarter, which helped lift the BoS survey indicator slightly. 

Domestic economic conditions remained favourable outside of the prairies, which are home to the oil-producing provinces of Canada, while most notably the outlook for the export side of the economy was also relatively upbeat. Forward-looking indicators of foreign sales were still positive in the third quarter, albeit that they were also being weighed down by "trade tensions", with export demand from the U.S. and rest of world as well as the level of the Canadian Dollar said to be supporting the outlook.

Above: BoC Business Outlook Survey indicator trend. Source: Bank of Canada.

"While the impact of trade uncertainty on the rest of the country could potentially ease if the US and China decide to make nice, some challenges in the energy sector (eg. pipeline shortages) cannot be so quickly solved," says Josh Nye, an economist at RBC Capital Markets. "But, for now, these survey results – although from a limited sample of about 100 firms – will probably only reinforce the Bank of Canada’s view that rate cuts are not immediately needed." 

Pricing in the overnight-index-swap market has barely moved since the BoS survey was released on Tuesday, with investors still looking for the BoC cash rate to sit just three basis points below its current 1.75% level at year-end, which suggests the market sees little chance of a rate cut this side of the New Year. Investors have been watching Canadian data closely for signs of the BoC being compelled to follow its global counterparts by lowering borrowing costs for companies and households. 

Canada's economy has outperformed major rivals this year, enabling the BoC to stand pat even as the Federal Reserve and other central banks have cut their own rates, which has driven the Loonie to the top of the league table of so-called G10 currencies for 2019. However, the BoC says this strength is temporary, markets are attuned to the risk that a turn lower in the economic data could force the BoC into action and technical factors on the charts are now complicating the outlook for the Loonie. 

"The pair has neared interesting technical levels. We have received questions as to whether USDCAD can breach trend support (from the 2012 lows) near 1.3080 and open more significant breakdown sub-1.30. We are sympathetic to this view, but we do not think the election results get us there," says Mazen Issa, a strategist at TD Securities. 

Canada's Dollar rose against its U.S. and British rivals following Tuesday's survey but the advance against the greenback has seen the Loonie run head-on into a key trendline that is barring the path higher for the time being and inciting the currency into a downward correction. Issa says the trendline, which coincides with the 1.3080 level of USD/CAD, can eventually be overcome but that in the meantime stock market price action is a risk to the Loonie.

"Relative curve and rate spreads should at the very least keep the pair anchored to the bottom end of a broad 1.30/34 range. Emerging optimism over trade add more scope to remain there as the case for immediate BOC easing dissipates. In the near-term, we are focused on risk sentiment and the data. With the S&P 500 at the highs and a boatload of earnings releases in the coming days, it may be prudent to be cautious," Issa writes, in a note to clients. 

Above: USD/CAD rate and S&P 500 index (orange line, left axis) shown at daily intervals.

Canada's Dollar has always had a correlation with the S&P 500 index and although the strength of the relationship varies over time, in recent months it the correlation has increased while the influence of interest rate differentials and oil prices has reduced. However, corporate earnings season is underway and the S&P 500 is close to record highs despite an uncertain outlook for the global economy. That could mean the index is vulnerable, along with the Loonie. 

However, others see recent progress toward opening a new chapter in the Brexit saga as well as in efforts to ratify the reformed North American Free Trade Agreement (NAFTA) providing further support to the Canadian Dollar in the weeks ahead. Rebels in the UK parliament have all but barred the path toward a potentially damaging 'no deal' Brexit and opposition lawmakers in the U.S. are making encouraging noises about passing the USMCA before Thanksgiving. 

"If optimism on a Brexit deal continues to fuel global appetite for risk assets, we don't see reasons to exclude an extension of the recent CAD outperformance. Indeed, the loonie is still the most attractive G10 activity currency thanks to its supportive rate outlook and stabilising commodity prices. In addition, the long-awaited ratification of the USMCA by the US Congress seems very near," says Francesco Pesole, a strategist at ING. "We see it as a positive factor for CAD. In turn, we don't exclude a break below 1.30 in USD/CAD in the near future, although some tangible improvements on the US-China trade negotiations will be needed to maintain the pair below that level."

Time to move your money? Get 3-5% more currency than your bank would offer by using the services of a specialist foreign exchange specialist. A payments provider can deliver you an exchange rate closer to the real market rate than your bank would, thereby saving you substantial quantities of currency. Find out more here.

* Advertisement