The Canadian Dollar is a Bargain Buy as NAFTA Progress Looms and Chart Signals are Turning Bullish

- US and Mexico NAFTA deal is close and Canada is back at table.  

- BoC outlook, valuation suggests more CAD upside in the Cards.

- Charts are pointing to a positive medium-term outlook too. 

© Pavel Ignatov, Adobe Stock

The Canadian Dollar is a bargain buy prospect on several counts including a looming breakthrough in North American Free Trade Agreement (NAFTA) talks and chart signals that now suggest a bullish outlook for the currency. 

A partial resolution to the NAFTA dispute could be announced imminently, according to a Politico report, and although the deal is only expected to be a between the US and Mexico the Loonie could still gain some favour from it since markets might infer a Canadian deal also becomes more likely.

Other fundamental positives include expectations the Bank of Canada (BOC) will raise interest rates in October thanks to recent strong data and resilient oil prices. 

From a technical perspective, a strong downtrend favours more weakness for GBP/CAD and USD/CAD is also trading with a bearish bias, according to analysis from Scotiabank.

NAFTA Saga almost Over?

President Donald Trump hinted a deal with Mexico could be imminent in a Tuesday night saying; "We’re on our way with a good deal — a fair deal with Mexico."

However, the Office of the U.S. Trade Representative subsequently said no deal had yet been reached and that there were still "major issues" outstanding. White House press secretary Sarah Sanders stopped short of confirming a forthcoming 'handshake' agreement.

"I’m not going to get ahead of any potential announcement. For decades, NAFTA has harmed American workers and cost the U.S. billions of dollars. We’re focused on making sure we deal with and address those problems, and we’ll let you know when we have an announcement," says Sarah Huckabee Sanders, White House Press Secretary, late on Wednesday.

Bank of Canada Outlook Supports CAD

Markets continue to expect the BOC to raise rates in the autumn, with Overnight Index Swaps (OIS) still fully pricing a 0.25% rate hike for October. Some have even speculated the BoC could raise rates in both September and October, much like the back-to-back rate hikes announced in July and September 2017.

Higher interest rates are likely to boost the Loonie because the are a draw for foreign investment due to the higher returns on offer, and thus increase capital inflows. 

Interest rate differentials are another way of valuing the exchange rate between two currencies as the difference between the bond yields of two countries enables analysts to produce "fair value" estimates as well as assess which way capital may be flowing.

"Yield spreads remain CAD supportive, hovering just above their recent lows, and our current fair value estimate for USDCAD is at 1.2854," says Shaun Osborne, chief currency strategist at Scotiabank.

With estimates of 'fair value' in the 1.28s and the market in the 1.30s, his analysis suggests more downside is could be in the cards for the Canadian Dollar. Although bond yields, along with this "fair value" estimate itself, could change quickly in response to rate hikes and progress in the US-Canada NAFTA negotiations.

Wednesday's disappointing retail sales data did not make a strong impression on the market and the loonie appeared to ride it out.

Canadian retail sales declined 0.2% in June, missing the estimate of -0.1%, yet the soft reading did not spook investors who may have viewed the result as unsurprising in light of the upwardly-revised 2.2% increase seen back in May.

Technicals Also CAD Supportive

Charts are looking bearish for the Pound and Dollar but bullish for the Loonie. If not now, then in the weeks to come the Canadian Dollar should rise. 

Recent GBP/CAD gains are unlikely to hold as the broader trend is downward, a resumption of which could take the exchange rate back down to the 1.60 to 1.65 region according to Scotiabank's Osborne.

Above: Scotiabank chart showing GBP/CAD rate technical analysis.

The USD/CAD outlook is also relatively bearish so long as the market remains below 1.3050, which is a "double top trigger" on a closing basis.

This provides some confidence of a decline to the 1.29s where there is a "knot of resistance" that could impede further weakness.

"However, we also think that a break below this support zone will strengthen broader downside risks for the USD in the coming weeks," says Osborne.

Above: Scotiabank chart showing USD/CAD rate technical analysis.

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