USD/CAD to Head Higher says BofA Strategist

The Canadian Dollar may have peaked and the Dollar stands to recover lost ground argues FX strategist Kamal Sharma with Bank of America Merrill Lynch who has briefed clients on his bank's emergent pro-USD/CAD stance.

"With our oil analysts expecting little in the way of a meaningful rally in crude price, we think that the recovery in USD/CAD could continue in the weeks ahead," says Sharma.

The Canadian Dollar has been rallying strongly - especially against the Dollar - with USD/CAD falling to new lows of 1.2412 in July, however, since then it has turned around and moved higher, and the Sharma sees this as a key turning point for the pair with further upside on the horizon.

At the time of writing USD/CAD is at 1.2672.

A key support for the Canadian Dollar of late has been the more hawkish policy of its central bank, which lifted interest rates from their record lows at their last meeting.

But, Sharma, unlike the market consensus, does not see another rate hike from until Q1 2018, when estimates are for another rise in 2017.

Optimism from the Bank of Canada will soon turn to concern at the exchange rate which is so high now it is hurting exporters.

This should curb any enthusiam for a rate hike.

"Whilst the Bank of Canada has so far been relaxed about the appreciation of the CAD, it will be concerned that the Canadian trade balance has moved sharply back into deficit in recent months. In 2017, virtually all the improvement in the trade balance has been given back," says Sharma.

Positioning is also stretched on futures markets with the neumebr of large speuclators and fund who hold bullish derivatives positions in the Canadian Dollar peaking, whislt those for the US Dollar are at a yearly trough low.

Positioning data is used as a contrarian indicator, so, a peak in the Loonie and trough in the greenback signals an increasaed chance of a switch in positions occuring and the Dollar recovering versus the CAD.

BofA's 'quant' forecasting model which uses options data - which are a type of leveraged derivative - is signalling more upside.

"MAA is starting to pick up. In addition, the Residual Skew for calls indicates a likely rally in spot. The topside options demand suggests a reversal in investors’ conviction. Up-down volatility is no longer bearish," said Sharma.

A technical analysis further supports a constructive forecsast.

Sharma notes how the pair has fallen to robust support from a long-term trendline, "the May 2016 lows and just above the rising 200wk simple moving average."

The techncial overselling echoes the overstretched positioning from Futures exchnages as, "oversold conditions reached some of the deepest on record since 2007."

Sharma highlights 1.2850 and then 1.3000 as a significant levels and targets higher (current market level is 1.2659).

His recommendation is more bullish, though with a call to buy at current market levels (1.2680) with a target at 1.3225 and a protective stoploss at 1.2425.