Canadian Dollar Tipped for One Last Huurah before Fundamentals Arrest USD/CAD's Fall

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• GBP/CAD spot rate at time of writing: 1.7241
• Bank transfer rate (indicative guide): 1.6675-1.6795
• FX specialist providers (indicative guide): 1.7022-1.7159
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The Canadian Dollar was walking wounded Friday having fallen against the U.S. Dollar, Pound and other major rivals but forecasts from BofA Global Research suggest it has scope for one last huurah in the months ahead, before fundamental forces demand an eventual readjustment to the downside.

Canada's Dollar enjoyed a short-lived boost early in Friday's North American session as investors, traders and other participants digested December's job reports from both sides of the southern border, although earlier selling pressures soon reasserted themselves in USD/CAD, GBP/CAD and others. 

Much like with its counterpart across the border, the Canadian labour market cracked in December as a second wave of coronavirus infections saw brought incremental closures of some businesses, and restrictions on other forms of activity, to more provinces from November through year-end. 

"The data highlight what is an increasingly bifurcated economic backdrop, with resurgence of virus cases and containment measures dramatically curtailing activity in the hospitality/travel sectors, while other industries have continued to broadly improve," says Nathan Janzen, a senior economist at RBC Capital Markets. "Job losses in December were, as has been the case throughout the entire COVID-shock, concentrated among those at the low end of the wage scale. That, of course, is not a good thing, but government income supports (expanded EI payments, and the new CRB program) continue to provide a significant income offset." 

Above: USD/CAD shown at 15-minute intervals.

62.6k jobs were lost last month, according to Statistics Canada, more than the -32.5k fall that conensus estimates envisaged. This helped lift the unemployment rate from from 8.5% although at 8.6% it stopped short of the 8.7% implied by consensus.

December's contraction more than wiped out the 62.1k gain seen in the prior month, making for a worse outcome than the also-negative numbers seen over in the U.S., where the economy clung on to around half of the prior month's increase as the official unemployment rate held steady. 

Both countries and economies were subjected to new restrictions around the same time as incremental waves of coronavirus infections swelled, although the slightly more resilient performance across the Southern border is a real world example of relative U.S.-Canada fundamentals that are forecast to arrest USD/CAD's fall later in 2021.

"We remain sanguine on prospects for the global cycle," says Ben Randol, a strategist at BofA Global Research. "We continue to expect positive implications accruing to cyclically-sensitive CAD."

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

Randol and the BofA team estimate that fair value and fundamental equilibrium sits around 1.29 for the main Canadian exchange rate USD/CAD, but they also judge that U.S.-Canada economic and financial fundamentals are not likely to deteriorate in 2021. This likely means that USD/CAD's fair value will remain around 1.29 this year and that by implication, any renewed Canadian Dollar uptrend and USD/CAD downtrend will simply take the Loonie further into the realm of 'overvalued' currencies. 

"Our commodities research team’s forecast of $47 for 2021 as a whole, thus suggesting limited CAD upside from the terms of trade channel. However, the potential for ever-firmer risk appetite amid generalized USD softness could spur further undershoot below our USD/CAD medium-term fair value estimate of 1.29. We do not see CAD positioning as extended in the leveraged community, which allows some room for the undershoot to deepen," Randol says.

Overvaluation can act as a natural constraint for exchange rates over time, and more so when one currency's central bank is fretting about exchange rate strength while the other has proven successful in sinking its exchange rate unit by as much as double-digit percentages in some cases over the last year. The Bank of Canada is in the camp of the former and the Federal Reserve the latter, which means looming decisions from each could be more instructive of the USD/CAD outlook than has recently been the case.

Above: USD/CAD shown at weekly intervals.

"Our expectation is for US-CA rate differentials to rise, provided that oil prices prove contained despite ongoing recovery. This should render further downside moves in USD/CAD ultimately unsustainable," Randol says. "The main risks to our USD/CAD forecast profile are risk appetite and oil prices...A robust recovery, euphoric risk seeking activity and oil price appreciation would suggest downside risks into the low/mid-1.20s. Alternatively, a bumpy recovery and risk aversion could see a return above 1.30."

BofA Global Research forecasts one last huurah for the Canadian Dollar before fundamental forces bring it back down to earth, with a vaccine-induced suppression of the coronavirus and an ongoing, general U.S. Dollar aversion among investors are likely to push USD/CAD down to 1.2600. 

USD/CAD is expected to remain through the first quarter before rising back to 1.29 in September and holding around there through year-end.

The Pound-to-Canadian Dollar rate is seen falling back to 1.7159 before the curtain closes on 2021. 

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