The Canadian Dollar Outlook has Dimmed; Buy USD/CAD, GBP/CAD say TD Securities

-CAD "everyone's most hated currency" as NAFTA and oil weigh.

-NAFTA risks rise as oil prices fall, creating toxic backdrop for CAD.

-Buy USD/CAD dips and bet on rise in GBP/CAD say TD Securities.

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The Canadian Dollar fell Friday financial markets markets faced up to the increasingly likely prospect that efforts to rengotiated the North American Free Trade Agreement will now drag on toward year-end and as traders responded to the latest developments in oil markets.

Canada's Foreign Minister Chrystia Freeland told reporters Thursday that Canada, Mexico and the US will continue negotiations to update the pact throughout the summer, suggesting ministers from neither country expect the talks will conclude before the July 01 Mexican Presidential election that is thought will bring a hardening of the Mexican stance on the subject of NAFTA. 

In addition the price of North American oil, which is Canada's largest export, has fallen by nearly 6% during the last month and is expected to decline further as speculation over a possible change in Organization of Petroleum Exporting Countries (OPEC) production during the coming weeks builds. WTI Crude oil prices had previously risen by 16% for the 2018 year, although they are now up by just 10.29%.

"External dynamics are starting to shift into reverse for the CAD – with both US-Canada trade tensions and lower oil prices weighing on the loonie. The former is set to be a perennial threat to CAD this summer," says Viraj Patel, an FX strategist at ING Group.

Securing a new deal is important for Canada and the Loonie because some analysts have estimated the currency could fall as much as 20% if the White House goes for the nuclear option and announces a US withdrawal from the agreement. This would set the clock ticking on a six month termination period.

Negotiators have been attempting to reform the NAFTA pact for close to a year now, at the behest of President Donald Trump. Thursday's downbeat commentary on the prospect of a deal comes as markets brace for the latest round of White House trade tariffs against the China and a possible retaliation against them.  

"On the oil side, the OPEC semi-annual meeting (22 June) could see a gradual easing of production cuts and as such, the likelihood is that we’ve seen a short-term peak in oil prices. Risks of a dovish BoC policy re-pricing means USD/CAD could run even higher up to 1.32," Patel adds. 

The USD/CAD rate was quoted 0.22% higher at 1.3145 during the London morning Friday while the Pound-to-Canadian-Dollar rate was 0.41% hihgher at 1.7454. Canada's unit was also offered lower against all other developed world currencies.

Patel's is not alone in eyeing a potential run at the 1.32 level for the USD/CAD rate as, with the NAFTA, oil and Bank of Canada (BoC) interest rate outlook in mind, other strategists have also warned during recent days of more losses in store for the Loonie. Markets have been betting the BoC will raise rates three times before March 2019, but analysts say this has left the Canadian Dollar exposed to the risk of disappointment.

"The 2y rate spreads imply a level around 1.32, and we think it is likely we get less rather than more from the BoC," says Mark McCormick, North American head of FX strategy at TD Securities, in a recent note. "We also like the medium-term story in GBPCAD topside with our forecasting implying a break of 1.80."

McCormick descibes the Loonie as "everyone's most hated currency at the moment" given its repeatedly frenetic gyrations betweeen two extremes during the year to date. The USD/CAD rate has fallen as low as 1.22 in 2018 and risen above the 1.30 level on no less than three occasions, trading within a large 10 cent range.

"The movements are seemingly random as it waffles from headline to headline. It has decoupled from some its key drivers, though we pin this down to NAFTA noise," the strategist adds. "One of the notable points is that USDCAD is trading with little bias, suggesting room to move up or down. Our [high frequency fair value estimate] sits at 1.30 and has been nudging higher on the bump in rate spreads and the pullback in oil."

McCormick and the TD Securities team have advocated that clients of the bank use any downward move in the USD/CAD rate toward the 1.2750 level to "buy on dips". They've also recommended using options, which are comples derivatives, to bet on a rise in the Pound-to-Canadian-Dollar rate during the months ahead.

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