Canadian Dollar to Rise against Pound and US Dollar say Strategists

-Sell the USD/CAD, GBP/CAD and EUR/CAD rates say strategists.

-Rising Canadian economic momentum supports brighter BoC outlook.

-Market is still "short" CAD but better data can drive steady reversal.

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The Canadian Dollar is on the cusp of a rebound against its major rivals now momentum within the economy is picking up, according to some analysts, who are arguing that traders should sell the Pound-to-Canadian-Dollar and USD/CAD exchange rates.

Sentiment toward the Canadian currency has improved in recent weeks, particularly after official data showed economic growth surging in May and exports rising at a rapid clip during June, placing the economy on track to deliver a solid performance for the second-quarter. 

Canada's trade deficit shrank to just -$626 million during June which, down from -$2.7 billion in May, after exports surged by 4.1% to a record $50.7 bn.Canadian GDP rose by 0.5% in May, up from 0.1% previously, placing the economy on track to achieve annualised growth of around 3% for the second quarter. 

This has helped reverse the tide of increasingly negative sentiment, stemming from uncertainty over the future of the North American Free Trade Agreement (NAFTA), that had driven the Loonie to year-lows back in June and July. Now, stratregists are flagging the potential for the Loonie to recover some lost ground during the weeks ahead. 

"Q2 CAD GDP is tracking just north of 3% which implies that a September/October hike is in play for the BoC," says Bipan Rai, a macro strategist at Toronto-headquartered CIBC Capital Markets. "We see only around 6bps priced in or around 25% probability that the Bank hikes then. Granted, we regard October as more likely but market pricing for September should be a bit more aggressive."

Above: USD/CAD rate shown at daily intervals.

The recent improvement in economic data is significant for currency markets because it is seen making a third 2018 interest rate rise from the Bank of Canada (BoC) more likely, when just a few short weeks ago, analysts and economists were sceptical about whether the BoC would manage another hike this side of the New Year. 

Changes in interest rates, or hints of them being in the cards, are only normally made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"The market is still short CAD and the positive impulse from incoming data should see shorts closed and stops triggered below the 100-day SMA. Our in-house valuation has USD/CAD closer to the 1.2800 handle but we also like the technical setup for a test of 1.2600," Rai adds. "On the USD leg: We’ve run out of ways to tell you how overvalued it is."

The Bank of Canada raised its interest rate for the fourth time in the last 12 months this July, taking it up to 1.5%, and signalled its intention to continue withdrawing stimulus from the Canadian economy over the coming quarters.

Most measures of Canadian inflation are already at or above the BoC's 2% target, while the Bank said in July that it expects this to remain the case out until at least 2020. 

"Conviction in the trade is moderate given the political climate," warns Rai. "The CAD still faces the same long-term strategic headwinds from the reduction in global liquidity and an over-indebted household sector. Additionally, the BoC is closer to its neutral rate than other central banks are."

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

Pricing in overnight index swaps markets, which enable investors to protect themselves against changes in rates but also provide insight into expectations for monetary policy, implied an October 24, 2018 cash rate of 1.68% Friday. But the implied rate for September 05 is just 1.57%, suggesting markets are currently leaning more toward an October hike. 

Rai says any shift in this wager by the market to favour a September rate rise would be enough to give the Canadian Dollar a lift during the weeks ahead. 

He and the CIBC team also say clients can sell the Pound-to-Canadian-Dollar or the Euro-to-Canadian-Dollar rates instead of USD/CAD, if they are uneasy about backing the Canadian currency while simultaneously betting against a resurgent US Dollar. This also rhymes with the latest quantitative analysis from Bank of America Merrill Lynch. 

"OCTAVE is bullish CAD with CAD outperforming on relative rates and equities. CAD is supported with second-highest carry and a solid rates trend in OCTAVE. In addition. our positioning model is bullish CAD on the crosses," says Vadim Iralov, a quantitative strategist at Bank of America Merrill Lynch. "GBP/CAD and EUR/CAD both show bearish signals, favoring CAD."

The Bank of America quantitative team do not say they are recommending betting on the Canadian Dollar, but the CIBC do. They have entered a short USD/CAD trade at 1.2980, have a stop loss at 1.3150 and are targeting a move down to 1.2600 during the weeks ahead. 

The USD/CAD rate was quoted 0.35% lower at 1.3034 Monday while the Pound-to-Canadian-Dollar rate was 0.15% lower at 1.6846 and the EUR/CAD rate was 0.15% higher at 1.5040. 

Above: Euro-to-Canadian-Dollar rate shown at daily intervals. 

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