Canadian Dollar Ripe for a Correction say Some, but Barclays Forecast Further Gains

- CAD at risk of pullback
- Positioning looking stretched
- Commodity price pullback also cited
- But Barclays favour further upside

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The Canadian Dollar is ripe for a correction says a prominent foreign exchange market analyst we follow, however the assessment at Barclays is that further gains can be realised.

Jeremy Boulton, a Reuters market analyst who provides market insights to traders and analysts, says the Canadian Dollar is "ripe for correction" at the start of the new week and that any vulnerability could arise from a turn lower in the commodity sector and increasingly exuberant investor sentiment.

"Commodity prices have peaked since inflation worries jumped," says Boulton, which could have implications for the outlook of the Canadian currency as "bullish CAD bets are the only real wager on a commodity currency rising".

Commodity prices and commodity currencies were on alert at the start of the week as Chinese authorities initiated a fresh intervention in the market, which they believe to now be driven by speculative excess.

The move "has triggered wave of profit taking," says Boulton. "Iron ore has dropped 25% in 8 days, copper down 9% in 10 days."

Analysis shows that Chinese demand for commodities might have peaked, while authorities held a meeting with iron ore, steel, copper and aluminium producers in Beijing and sent a warning that collusion and speculation in commodity markets will not be tolerated.

The news has been credited by analysts as being behind steel prices dropping more than 5% and iron ore falling by close to the daily limit before steadying later in the session.

"China has stepped up its campaign to try and keep a lid on raw materials prices, vowing severe punishment for violations ranging from excessive speculation to spreading fake news," says John Meyer, Head of Research at SP Angel.

The developments have had impacts on most major commodities, including that which is most relevant to the Canadian Dollar: oil, which is is now $3/barrel below last week's best.

Calls for caution come as the Canadian Dollar holds its title as the best performing major currency of 2021, gaining as commodity prices rise and the Canadian economy recovers from the Covid-19 crisis, no doubt finding support from the stimulus-fuelled boom below the border in Joe Biden's USA.

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The Pound-to-Canadian Dollar exchange rate (GBP/CAD) has lost 2.0% in value in 2021, with a 1.0% decline coming in the past month, and is seen at 1.7060 at the time of writing.

The U.S. Dollar-to-Canadian Dollar exchange rate (USD/CAD) has meanwhile lost 5.0% in value, with 2.73% being lost over the past month taking the pair to 1.2064.

But the rally in the Canadian Dollar leaves it looking potentially overbought in the near-term with the number of contracts in the market looking to benefit from further gains nearly tripling in May alone.

"Speculative accounts added $630MN to net CAD longs now totalling $3.8BN - the highest mark since November 2019 - as shorts begin to more clearly capitulate to the CAD’s strength with USDCAD trading just shy of the 1.20 level, a six-year low," says Shaun Osborne, Chief FX Strategist at Scotiabank.

An over-subscription in the trade could yet prove to be the Canadian Dollar's greatest near-term headwind.

Boulton says he sees a risk of a pullback towards 1.2258 in USD/CAD.

Although the Canadian currency might suffer some near-term headwinds foreign exchange strategists at global investment bank and financial services provider Barclays maintain their bullish medium-term stance.

For Barclays, the Bank of Canada (BoC) is likely to remain a supportive force for the CAD given it opted to reduce its quantitative easing programme on April 21.

The BoC will now buy C$3BN of government bonds per week, down from C$4BN in the five months heading into the meeting.

When a central bank tightens monetary policy via either raising rates or reducing quantitative easing - while other central banks are still offering generous support - the currency that central bank issues tends to appreciate in value.

"While a lot of the BoC hawkishness now seems to be priced in, we think the loonie should stay supported in the medium term as the economic outlook remains optimistic and has not been materially derailed by the third COVID wave," says Barclays in a weekly foreign exchange research briefing.

Aiding this stance is the observation that Canada has seen an impressive pickup in the pace of vaccinations amidst a surge in supply and strong demand that means it is set to overtake the U.S. in terms of vaccination rates.

"The share of people in Canada who have received at least one dose of vaccine has crossed that of the US and new cases have fallen swiftly. Global growth and reflation in a backdrop of positive risk sentiment supported by the Fed’s dovish stance also supports the loonie against the dollar," says Barclays.