Canadian Dollar Retreats, Now at Key Crossroads

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- CAD retreats from October 2018 high, at an inflection point.

- Regaining 1.30 this week key to outlook says CIBC and TD.

- CIBC says to wait for jobs data as TD bets on USD/CAD rise.

- Parity in interest rates makes CAD only option for USD bears.

- GBP/CAD at risk of steeper fall, Scotiabank analysis suggests.

The Canadian Dollar is at a crossroads from which it could head in either direction, with local analysts saying this week's price action will be key to the medium-term outlook for the currency.

Canada's Dollar has been a top performing global currency over the course of the past week, but came under some pressure on Tuesday and retreated from its highs, "as oil weakened and the greenback strengthened," says Joe Manimbo, a foreign exchange strategist with Western Union in Washington.

Canada is a notable exporter of crude oil, relying on the commodity for a significant portion of its foreign exchange earnings basket, and a 0.7% decline in oil pushed benchmark crude prices below $63.

While the Loonie has seen some short-term pressure courtesy of softer oil, trend momentum remains positive and the currency could push to new highs against the greenback, Pound and other currencies in the coming months, according to CIBC Capital Markets.

"If you’re an exporter, or have exposure to USD investments – wait for the data this week. If the data outperforms and USD/CAD can’t reclaim the 1.30 handle then there’s a very good chance that USD/CAD will test the 1.27 area. If not – then we’ll hold firm to our view that USD/CAD will continue to remain rangebound, that USD/CAD dips should be bought and that longer-dated vols are where it’s at," says Bipan Rai, North American head of FX strategy at CIBC. 

Above: USD/CAD rate shown at daily intervals, lifting off its October 2018 low.

Rai and many others are waiting with bated breath for the December jobs report that's set to be released by Statistics Canada at 13:30 Friday, given that November's numbers revealed a sharp increase in unemployment that shocked the market and sent the Loonie tumbling at the beginning of last month. Consensus is looking for a 31.8k increase in the employment to partially reverse the huge 71.2k contraction reported for November but Rai is looking for a second consecutive disappointment. 

"There’s good reason to look for that as well given how hiring in Canada has outpaced actual output by a wide margin over the past year. One would expect the labour market to revert back to more normal levels like they did in the early 2000’s and just before the crisis in 2007," Rai says. 

Whether Canada's jobs market came roaring back in December or deteriorated further will be key to if the USD/CAD rate can achieve a weekly close above the 1.30 handle, which is necessary if the Loonie's upward climb is to be stymied in the weeks ahead. And that will in turn determine at least in part, the outlook for other exchange rates including the Pound-to-Canadian-Dollar pair. 

Above: CIBC Capital Markets graph showing divergence between growth in the Canadian economy and labour force.

Investors' appetite for the U.S. Dollar and riskier rivals is said by many to be the main driver of price action in the currency market at the moment but Friday's jobs report could play a significant role in determining the next steps at the Bank of Canada (BoC). The BoC's 1.75% cash rate has rendered the Loonie the only comparable alternative to the U.S. Dollar because lower rates elsewhere have made it expensive to bet against either with other currencies.

"25k jobs created will replace only some of those lost in November and leave the Canadian labour market on a softer footing into year-end. This should allow the unemployment rate to recover to 5.7% and while wage growth is projected to hold in at a solid 4.0% y/y, further disappointment may amplify concerns over the financial wellbeing of Canadian households," says Mark McCormick, global head of FX strategy at TD Securities, in a note to clients Monday. "USDCAD likely to base ahead of 1.2950. For our first [Trade-of-the-Week], we buy USDCAD, looking for a partial reversal of the recent strength in CAD."

CIBC bet on a fall in the USD/CAD late last year but exited the trade ahead of the Christmas holiday on December 24, just as the exchange rate was approaching the 1.31 level. The bank is now watching and waiting to see what happened in the labour market during December before doing anything else although TD Securities, another Toronto-headquartered firm, has told clients to buy the USD/CAD rate this week and target a short-term move up to 1.3150.

Above: Pound-to-Canadian-Dollar rate shown at daily intervals.

Any increase in USD/CAD will undoubtedly have implications for the Pound-to-Canadian-Dollar rate although the exact effect will depend on whether the move is prompted by Friday's jobs report or something on the U.S. Dollar side. 

The GBP/CAD rate always closely matches the GBP/USD rate divided over the CAD/USD rate and if the U.S. currency is drives either of those rates at any point it will also impact the other and to at least some extent, nullify the impact on GBP/CAD. However, if it's Canadian Dollar weakness that drives CAD/USD lower and USD/CAD higher then the Pound-to-Canadian-Dollar rate would be likely to receive a boost. And it's the Canadian Dollar that will be reacting to Friday's jobs report, for better or worse. 

Pound Sterling enjoyed a strong 12.5% increase between the beginning of August and the early weeks of December 2019 as the risk of a 'no deal' Brexit faded but it's since been beaten back into a renewed retreat by the rampant strength of the Loonie. And technical analysis from Canada's Scotiabank suggested on Monday that further declines could be in the pipeline. 

"GBPCAD traded sideways through the New Year period," writes Scotiabank's Juan Manuel Herrera in a research note. "The mid-Dec swing lower in the GBP, which formed daily and weekly bearish reversal signals in the process, implies that a downside bias will persist for the cross in the near term at least. We rather think the extended run higher form the Aug low point may have further to correct, potentially to the 1.65/1.67 region, before the cross can stabilize."

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