Pound-to-Canadian Dollar Week Ahead: Overbought on the Charts and Vulnerable to Correction

- GBP/CAD in overbought territory and vulnerable on charts.

- After rising 2.15% in largest weekly gain since September.

- As oil prices, BoC's 50 basis point rate cut weigh on CAD.

- Oil, Italian quarantine downside risks to CAD in week ahead.

- As UK's 2020 budget set to bring fiscal stimulus Wednesday.

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- GBP/CAD Spot rate: 1.7657, up +2.15% last week

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The Pound-to-Canadian Dollar rate has entered overbought territory on the charts and may now be vulnerable to a correction lower after posting its largest weekly gain since September last year.

Pound Sterling underperformed most of its major rivals last week but not the Canadian Dollar, which was the worst performing major currency after the Bank of Canada (BoC) announced its largest interest rate cut for 10 years, oil prices collapsed again and global equity markets crumbled further amid signs the coronavirus is spreading with increased momentum in Europe and the U.S. 

Canada's Dollar lost its status as the highest yielding major currency after the BoC's rate cut, leading investors to sell it en masse and helping lift the Pound-to-Canadian Dollar rate 2.15% from near 2020 lows, back toward December's high. But Sterling has strayed beyond the upper Bollinger Band on the daily chart and is touching the upper band on the one and four-hour charts, suggesting the exchange rate is what technical analysts call "overbought".

Furthermore, the relative-strength-index (RSI) has carved out a series of lower highs over the last week even as the exchange rate itself went on to repeatedly set new 2020 highs, giving rise to what's known as 'bearish divergence' on the charts. Bearish divergence suggests the uptrend is waining and that the is Pound potentially becoming vulnerable to a downward correction. 

The below chart shows the Pound-to-Canadian Dollar rate trading at daily intervals and rising above the upper Bollinger Band last week as the RSI in lower pane fails to set new highs.

Above: Pound-to-Canadian Dollar rate shown at daily intervals with Bollinger Bands and RSI (lower pane) marked out.

Bollinger Bands represent two points that are two standard deviations away from an exponential moving average and, theoretically, the gap between the two marks out the area in which an asset should trade 95% of the time or more. 

When prices break above or below the upper or lower bands it's normally considered to be the case that prices will soon move back inside the bands revert toward the mean, in other words the exponential moving average. When a price is below trhe lower band the asset in question is "oversold" and when prices are above the upper band, as is the case with the Pound-to-Canadian Dollar rate, they are then "overbought".

Sterling has also been left testing its upper Bollinger Bands on the one-hour and four-hour charts after last week's rally and when these factors are combined with the bearish divergence seen with the RSI,  the Pound is left looking even more vulnerable to a correction. Buy what matters most for the Pound-to-Canadian Dollar rate is the relative performance of the GBP/USD and USD/CAD rates, because the GBP/CAD is simply the former over the latter. 

GBP/USD rallied strongly into the weekend and although it enjoys a bullish set-up on the charts, it remains to be seen whether Sterling will retain the upward momentum it had in the second half of last week. Likewise with the USD/CAD rate, which rose sharply in the wake of the BoC's rate cut. 

"The USD uptrend remains well-entrenched on the charts, supported by bullishly aligned moving average studies and bullish trend oscillator signals on the medium and longer term charts. On the other hand, there is clearly good USD supply emerging above 1.34 to curb CAD losses and USD gains are looking somewhat stretched against the TRIX indicator and on the Bollinger studies. We favour choppy range trade, with a slight bias towards USD gains while spot remains above 1.3375," says Juan Manuel Herrera, a strategist at Scotiabank.

Above: Pound-to-Canadian Dollar rate shown at daily intervals alongside USD/CAD rate (blue line).

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The Canadian Dollar: What to Watch

The Canadian Dollar was the worst performing major currency last week after the Bank of Canada radically reduced its yield advantage just as the bottom fell out of the oil market again, and with more losses likely just around the corner for oil, the Loonie could suffer further declines in the coming days. 

Canada’s Dollar ceded ground to every major rival including an uncharacteristically weak U.S. Dollar after the BoC cut its cash rate to 1.25% and as oil prices declined nearly 10%. Brent crude fell  more than 9% last week while WTI futures prices were down -7.17% following some of the worst losses for oil prices since the financial crisis, although both could fall further in the week ahead and potentially take the Canadian Dollar down with them.

“The price of oil has come renewed selling pressure following reports that OPEC+ talks are on the verge of collapse. Russia does not agree with the OPEC proposal for deeper cuts. It reinforces downside risks for the price of oil from demand disruption related to the coronavirus shock. At the same time, the BoC followed the Fed and delivered a 0.50 point rate cut and left the door wide open for further easing. The BoC has more room to cut rates than other G10 central banks posing downside risks for the CAD,” warns Lee Hardman, a currency analyst at MUFG.

Oil prices might see fresh downside Monday if markets view Italy's quarantine of around a quarter of its population denting the Italian, Eurozone and global growth outlooks. Canada’s Dollar is sensitive to the price of oil because it’s the country’s largest export, which also gives the Loonie a positive correlation with investor risk appetite.

Continued losses for oil prices would weigh on the Canadian Dollar and so too would any further deterioration of the interest rate outlook. The BoC’s Wednesday decision to lower the cash rate by 50 basis points has knocked the Loonie off its perch as the highest yielding major currency and may continue to weigh over the coming weeks given that it was followed by a clear warning that further rate cuts could be on the way. 

"We look for the Fed to ease again with 25bp cuts March and April, and if recent precedent is anything to go by the BoC is likely to keep pace with the Fed (the communique noted that the BoC would monitor conditions in coordination with the rest of the G7)," says Andrew Kelvin, chief Canada strategist at TD Securities. "Markets will doubtlessly fluctuate, but if the OIS curve still prices a high probability of an April cut this time next month Poloz may be unwilling to roil markets on the way out the door." 

Pricing in the overnight-index-swap markets implied on Friday that investors already expect one further rate cut from the BoC in April, taking the cash rate down to 1%, although if coronavirus takes a greater hold in Canada or other major economies then markets could easily come to expect even more easing from the BoC in the months ahead, which would weigh on the Loonie. 

Governor Stephen Poloz emphasised the bank’s readiness to act again on Thursday when he told a Women in Capital Markets event the BoC will cut its cash rate further if necessary to support growth and keep inflation on target. He also said negative interest rates "are considered as part of the bank's toolkit."

There is no major economic data due from Canada over the next week, which should leave the Loonie taking its cues from moves in broader financial markets and general investor sentiment. However, investors will likely also keep one eye on the government after Finance Minister Bill Morneau said last week the government could use the March 19 budget to announce a large fiscal stimulus designed to aid households as well as companies as Canada grapples with its own coronavirus outbreak.

“Although USD valuations are moving toward oversold extremes, recent breakdowns suggests that corrective rallies in the greenback will be met with selling interest.  USD/CAD is an exception, with recent price action pointing to an eventual move above the 1.3500 threshold,” says George Davis, chief technical strategist at RBC Capital Markets. “A daily close above the June 18 high at 1.3432 would uphold the current uptrend, shifting the focus up to 1.3497 (76.4% retracement) and 1.3565.”

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The Pound: What to Watch 

The Pound underperformed all major rivals other than the U.S. Dollar and the commodity currencies last week and it might remain a laggard over the coming days given the large scale quarantine now in force in Italy, although Wednesday’s budget poses upside risks to Sterling.

Pound Sterling will spend the early part of the week preoccupied by the quarantine of an estimated 17 million people in the Lombardy region of Italy, which was announced by Prime Minister Giuseppe Conte in the early hours of Sunday morning.  Around 14 provinces that are home to almost a quarter of the Italian population went into ‘lockdown’ Sunday and will remain subject to legal restrictions on the movement of people until at least April 03.

An emergency decree signed into law at the weekend requires that no citizens be able to enter or leave the affected areas and nor will they be able to move around inside the areas except for under certain circumstances. The government had already isolated some towns and villages in an effort to control a coronavirus epidemic that was unearthed a fortnight ago, although the weekend’s decree marks a significant expansion of the enforced isolation. 

"Trillions of dollars of market capitalization have been lost in the past couple of weeks. Financial conditions have tightened.  US, UK, and Australian bond yields have never been lower.  The US 30-year bond yield has never been below 2%, and now it is below 1.5%. German Bunds yields are near record lows of near minus 75 bp. Investors seem to be concluding that the Federal Reserve is heading back toward the zero-bound," says Marc Chandler, managing director at Bannockburn Global Forex.

It’s exactly the above kind of containment measure that’s widely believed to have brought China’s economy to a standstill this quarter and it could be the case that Italy, which was already in recession, now faces a similar hit. The news unlikely to be welcomed by the Pound given that Italy is one of the UK’s top ten trading partners, and that’s even before markets get to wondering whether such measures will eventually be seen in other major economies like the UK and the U.S. as both battle their own outbreaks.

The UK government is for the time being dealing with far less than the 5,883 cases that were confirmed in Italy as of Saturday and partly for this reason it’s taken a softer approach to containment than Italy although a weekend of headlines reporting panic buying in the shops suggests members of the public are taking the threat of an outbreak seriously. That could have negative consequences for the economy if it leads consumers to shut themselves away indoors in order to avoid infection.

“The economy started the year on a strong note, but it is only a matter of time before it succumbs to the effects of the coronavirus. To reflect the weaker global backdrop and the likelihood that measures implemented to limit the spread of the virus will dampen business activity and spending by households, we have revised down our GDP growth forecast for this year from 1.0% to 0.7%,” says Paul Dales, chief UK economist at Capital Economics. “We also now expect the Bank of England to cut interest rates from 0.75% to 0.50% soon and the Chancellor to announce in the Budget on 11th March an extra package of measures to help support businesses and households.”

Dales forecasts a 02% increase in UK GDP for the first quarter followed by no growth in the second quarter as the economy suffers from efforts to limit the spread of coronavirus in the UK, which had 205 confirmed cases of it as of Saturday with two deaths. Some major banks sent staff home from the Canary Wharf financial district last week while others have begun to spread key staff out over a number of different offices to minimise the risk to individual teams.

Measures taken in China during the height of its own outbreak turned cities of many millions desolate, exactly the same kind that were expanded in Italy at the weekend, and if replicated across the more than 90 countries battling the virus then the global economy could find itself in serious trouble.

Investors’ nerves have frayed of late  as the disease spread further across the globe including in the U.S. and Europe, leading them to sell stocks and other risk assets en masse. Equity benchmarks are now in correction territory, oil is in a ‘bear market’ and major economy bond yields have hit record lows as investors sought the perceived safety of sovereign debt. And central banks including the Federal Reserve and Bank of Canada have responded with large 50 basis point interest rate cuts, although in the UK attention turns to the government this week. 

“Fiscal policy will likely be the weapon of choice to accommodate the economic impact of the virus through measures such as the deployment of automatic stabilisers, targeted cash transfers (principally in health care) and/or allowing the spreading out over time of tax liabilities (the ‘time to pay’ measure announced this week),” says Abbas Khan, an economist at Barclays. “In the case of a COVID-19 major outbreak, we would expect the government to announce a boost in direct public spending commensurate with the extent of containment measures implemented. Of course, a prolonged pandemic could lead to debt-sustainability issues, if interest rates, already low, do not fall enough to offset a sustained primary budget deficit.”

Wednesday’s budget is the highlight of the week ahead for the Pound as far as the calendar is concerned and investors will be looking to see how the Treasury intends to support the economy as the government grapples with coronavirus. Markets had been briefed to expect a large stimulus in the budget which many had hoped would be enough to avert a Bank of England (BoE) interest rate cut this year after the economy slowed heading into year-end, and expectations relating to this were the main source of support for the Pound in February. 

But the post-election ‘Boris bounce’ in confidence and output is now expected to give way to a virus-induced slowdown and as a result, investors are betting heavily that the BoE announces a rare 50 basis point interest rate cut to 0.25% on March 26. Pricing in the overnight-index-swap market implied on Friday, a 0.32% Bank Rate for March 26, which is close to the 0.25% that would prevail after a 50 basis point cut. 

With the OIS implied Bank Rate at 0.32% the market is already pricing-in a substantial monetary response from the BoE, which might not be fully delivered if Wednesday’s budget does reveal a substantial fiscal stimulus. Incoming BoE Governor Andrew Bailey did say last week that he would like more evidence of a coronavirus impact on the economy before cutting interest rates at all, and if markets come to doubt the likelihood of that large March rate cut then the Pound might find itself back in favour with the market for a time. 

The budget will be delivered in parliament by Chancellor Rishi Sunak at 11:30, just hours after the Office for National Statistics releases UK GDP data for January. Consensus is looking for the economy to have grown 0.2% that month, a slightly slower pace of growth than the abnormally strong 0.3% seen in December. The figures cover activity in the first full month after December’s election and will reveal whether there really was a Boris bounce in the economy after the Conservative Party’s landslide win. 

“We assume that the BoE will look to hold off from an emergency rate cut, favouring a 25bp move at the scheduled meeting on 26 March, in the process leaving additional ammunition,” says Bipan Rai, North American head of FX strategy at CIBC Capital Markets. “The upcoming budget on 11 March will see a nicely timed fiscal boost. Evidence of precautionary measures to alleviate corporate liquidity pressures will likely add to GBP/USD impetus. Look for a close above the 100day MAV at 1.2991 to open the way for gains to extend towards strong resistance at 1.3070.”