The Canadian Dollar is Seen Running Out of Gas as BoC and Federal Reserve Loom 

 Image © Pavel Ignatov, Adobe Stock

- CAD overcomes key resistance barrier but tipped to stall. 

- New consolidative range eyed by CIBC and TD Securities.

- As market waits on next week's Fed and BoC rate decisions.

- CIBC tips CAD lower in medium-term, TD eyes higher USD.

The Canadian Dollar has decisively overcome a key technical resistance barrier on the charts but is now tipped by CIBC Capital Markets and TD Securities to consolidate within a narrow range ahead of next week's central bank meetings, before declining gently over the medium-term. 

Canada's Dollar closed above a long-term trendline on the charts Thursday, leading to continued gains in the final session of the week and prompting speculation about the prospect of further upside being borne out over the coming days. However, with the Loonie remaining top dog out of the major currencies for 2019 and the economy expected to slow, some local analysts say the Canadian currency is most likely to run out of gas in the days ahead. 

"The seven-year trend line is under pressure. You’ll recall that this trend line started in September 2012 just after the Fed had announced QE3 and when oil was trading at $93-95/bbl," says Bipan Rai, head of FX strategy at CIBC, in a note to clients. "Trend line breaks are a matter of interpretation. And right now, our guess is that the market is reticent to endorse a break lower here. Instead, it feels as if the market may be moving into a new consolidative range."

USD/CAD achieved a daily close below 1.3080 this week due to weakness of the U.S. Dollar and strength in the Canadian Loonie, although the level coincides with the upward-sloping trendline marked out on the charts in recent years. The trendline has been in place ever since 2012 and this week's disruption of it could prove to be psychologically significant for the market, ultimately serving as a harbinger of further gains for the Canadian currency.

Above: USD/CAD rate shown at weekly intervals, with multi-year trendline displayed.

CIBC's Rai says that trendlines should always be regarded with caution and suspicion if movement from one side to another takes place only for a few days while the trend has been running for years. In this case, the Loonie has crossed rubicon for all of about 48 hours but has otherwise respected the trendline for some seven years. CIBC says this week's price action is unlikely to give way to fresh march northward and will instead augur a period of range-bound trading between 1.30 and 1.3350.

"We are more of the view that USDCAD is setting up to consolidate near current levels. For starters, the upcoming Bank of Canada decision is unlikely to rock the boat too much as economic projections will balance a better-than-expected 2019 with modest downgrades to 2020. The statement should retain messaging from September and keep the emphasis on global developments," says Mazen Issa, a strategist at TD Securities. 

Issa is mindful that U.S. Dollar strength could produce a bounce in the USD/CAD rate next week if the Federal Reserve (Fed) cuts its interest rate but neglects to sufficiently assure investors of more cuts to come in the months ahead. Markets have fully priced-in a third 2019 rate cut for next Wednesday and are also betting heavily on a further two cuts being delivered before the end of the first quarter next year, many analysts are increasingly questioning whether the Fed is minded to deliver them. 

Many analysts say it would take a pre-commitment to further cuts from the Fed, as well as signs of economic recovery in places like the Eurozone, to sustainably turn the Dollar lower. But Vice Chair Richard Clarida said last week the FOMC will continue to make decisions on a meeting-by-meeting basis. He also emphasised that "muted inflation pressures", weak global growth and signs of a slowdown in the U.S. were behind the July and September cuts.

Above: USD/CAD rate shown at monthly intervals, with multi-year trendline displayed.

"In conjunction with our [fair value] measure suggesting no value to be had here in chasing USDCAD downside, we are content in remaining sidelined on the pair for now. If anything, we think with the DXY set to make a turn tactically higher and equities looking frothy, the risk is that USDCAD starts to turn higher," Issa writes, in a note to clients. "The upcoming Bank of Canada decision is unlikely to rock the boat... statement should retain messaging from September and keep the emphasis on global developments."

TD and CIBC are looking for the Loonie to stall just days before the October 30 policy decisions of the Bank of Canada (BoC) and Federal Reserve. BoC policy has seen the Canadian cash rate held at 1.75%, while a global economic slowdown and rate cuts play out elsewhere in the background. That steady cash rate has played a significant role in the Canadian Dollar's 2019 gains so markets will listen closely next week for clues of any changes being in the pipeline for the near future. 

Canada's cash rate has sat unchanged at 1.75% all year and the BoC has said only that it will "pay particular attention to global developments and their impact on the outlook for Canadian growth and inflation" when making future decisions, even though four of the ten major central banks have already cut rates in 2019 and others could soon follow suit if their economies are snared by the ongoing deceleration of global growth. 

"Why would you short USD/CAD when the market has the Fed priced for two cuts by next June, but very little for the Bank of Canada in that same timeframe? This extension lower is being driven by broad USD weakness as opposed to endogenous CAD strength alone. That makes it difficult to short the pair strategically," says CIBC's Rai. "USD/CAD will move higher in the coming quarters as the CAD goes back to being a high beta play on the US economy. Our target is above 1.40 in H2 2020."

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