Canadian Dollar Forecast to Outperform Euro and Pound

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• GBP/CAD spot rate at time of publication: 1.7112
• Bank transfer rates (indicative guide): 1.6513-1.6633
• Transfer specialist rates (indicative guide): 1.6743-1.6958
• More information on specialist rates here

The Canadian Dollar was seen on the backfoot against Sterling heading through the mid-week session as investors rushed to buy the heavily-sold UK currency on signs of a potential softening in the UK government's position on a piece of domestic legislation that has soured relations with the EU. The Canadian currency was meanwhile firmer against the Euro and the U.S. Dollar, amidst a broad-based sell off in the Greenback.

However, the outlook for the Canadian Dollar is by all accounts not a stellar one according to the latest currency research briefing from Wall Street bank J.P. Morgan, however there is some tactical upside potential for the Canadian currency against the European duo of the Pound and Euro.

In a recent monthly currency briefing, analysts at J.P. Morgan say the Canadian Dollar will remain tied down by a current account deficit owing to a deterioration in Canada's terms of trade. The covid-19 crisis has exacerbated the trade deficit that sees Canada importing more than it exports, even after the recent recovery in global oil prices.

The net result is the the Canadian Dollar is left relying on the inflows of foreign investor capital for support, namely via investments in stocks and bonds which poses potential headwinds in the future.

"There remains the risk that CAD needs to adjust to balance its international trade and capital flows – or instead warrant an ongoing risk premium to compensate its external vulnerabilities," says Patrick R Locke, a strategist with J.P. Morgan.

Above: CAD performance in 2020

Despite some notable fundamental and structural headwinds, the Canadian Dollar has nevertheless outperformed over recent weeks as it plays catch-up with a global recovery in stocks and commodity prices.

While this recovery is not to be confused with genuine outperformance, Locke and his team say the Canadian Dollar could be a strong candidate for those looking to take advantage of any upcoming weakness in Sterling and the Euro.

"We hold a near-term tactical CAD long as a beta-hedged USD proxy vs a basket of EUR and GBP, designed to exploit Sterling’s near-term Brexit headwinds, and tactical EUR risk," says Locke.

The Canadian Dollar is expected to piggy-back U.S. economic outperformance, owing to Canada's proximity and reliance on the U.S. economy making it a useful proxy for traders looking to differentiate away from the U.S. Dollar when expressing a view on the Pound and Euro.

If the strategy is correct the Pound-to-Canadian Dollar exchange rate (GBP/CAD) could be in for further losses, having fallen a sizeable 2.70% last week.

This week brings with it some stability in Sterling, allowing GBP/CAD to retrace 1% of those losses and quote at 1.7035 at the time of writing.

J.P. Morgan are bearish on Sterling going forward, saying market sentiment around the currency has dramatically soured over recent days as investors are forced to face up to the very real prospect that the trade talks could founder.

"We remain bearish GBP given our view that risks to GBP from Brexit are still asymmetric to the downside given UK’s reliance on foreign capital and the lack of sufficient risk premium for a no-deal Brexit," says Meera Chandan, a strategist with J.P. Morgan in London.

The Euro is meanwhile expected to struggle alongside Sterling owing to Brexit anxieties, with J.P. Morgan saying while it does have some near-term upside potential it possesses a bearish longer-term outlook.

"Year–end target still above spot to reflect potential upside from US election risk premium, but tweaked from 1.20 to 1.19 for possible fallout from Brexit contagion. Medium-term forecasts extended to 1.16 in 3Q’21 to reflect skepticism around quality of European growth, negative rates and QE outpacing that of the Fed," says Chandan.