- USD/CAD risk still higher, says TD and CIBC
- A break of 1.30 considered likely for the coming months
- CIBC plans to climb to 1.33 as TD warns of 1.35
- Global Economic Risks, BoC Policy Outlook Cited
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The Canadian dollar has remained outperforming so far in 2022, but its rise and underlying factors are also green roots of a possible fall, according to CIBC Capital Markets, while TD Securities says upside risks are dominant for the USD/CAD in the short term.
The Canadian dollar topped the currency rankings within the G10 contingent for much of 2021 before entering the new year in second place behind the US dollar, a position it managed to hold until present in 2022.
This is a pattern of North American outperformance found when the currencies considered are expanded to include those of the broader G20 group, where the Mexican peso is also near the top of the rankings.
“Monetary policy in the United States and Canada has been largely consistent. The Fed and the BoC now appear determined to bring key benchmark rates back to neutral to rein in generational levels of inflation,” said Bipan Rai, North American head of currency strategy at CIBC Capital Markets.
“Both countries have benefited from a flexible fiscal policy in previous years. Although we expect to see some slowdown later this year, the effect on growth from previous years stands in contrast to other countries,” Rai and his colleagues said in a research briefing on Tuesday.
Above: Performance of the Canadian dollar in 2022 against its G10 counterparts. Source: British Pound Live.
According to CIBC, the outperformance of the Canadian dollar largely reflects the broadly similar market outlook for Federal Reserve (Fed) and Bank of Canada (BoC) interest rates, which are expected to rise from the current 1% to just over 3% over the next year or so period.
That in turn is the result of relatively robust economies that have benefited from heavy doses of government spending to a greater extent than those in other regions since the start of the coronavirus pandemic, although CIBC says things could turn around. quickly for the Canadian economy and the dollar.
“The market expects both central banks to end this rate hike cycle at around 325 basis points. However, we do not see this as a realistic conclusion to this cycle given the difference in leverage of the private sector in both economies,” Rai and his colleagues said on Tuesday.
“Given that Canadian households did not deleverage to the same degree as American households after the global financial crisis, a rate hike north of the border will be ‘worth more’ in terms of slowing real activity. As such, we believe the market is mispricing the BoC relative to the Fed,” they added.
Rai and the CIBC team say this ‘miscalculation’ of the Bank of Canada’s interest rate outlook should eventually drive the USD/CAD pair higher above 1.30 and towards the 1 level .33 in the coming months.
Above: USD/CAD displayed at weekly intervals with Fibonacci retracements of the 2020 fall indicating possible medium-term areas of technical resistance for the US Dollar and support for the Canadian Dollar. Click on the image for a closer inspection.
However, CIBC also warned that any intermediate dip below the 1.27 level would be an indication that the above scenario is unlikely.
“If the panic in equities reasserts itself over the next couple of weeks, we could see the USDCAD break through 1.3050 again and potentially 1.3150. What if the S&P 500 drops -25% YTD , we wouldn’t entirely rule out a USDCAD move to 1.3350 as Canadian pension plan managers reduce their short USDCAD hedges due to having fewer assets to hedge. this USDCAD move is already quite extensive at levels above 1.28,” says Greg Anderson, global head of FX strategy at BMO Capital Markets.
Meanwhile, TD Securities cited rising corporate financing costs and recent crushing losses for stock markets as part of a series of worrying indications about the global economic outlook.
This in turn would have negative implications for commodity currencies in the near future, including the Canadian dollar.
“Fear of stagflation is mounting and this is a potentially problematic environment in the near term for commodity-intensive currencies that require stable global growth to maintain their lofty status,” said Mark McCormick, global head of currency. FX strategy at TD Securities.
“These currencies are likely to underperform further against the EUR and JPY where their [terms of trade] the gains were most acute,” McCormick and colleagues wrote in a market commentary on Tuesday before warning that “we believe investors should be aware of a USDCAD return to 1.35.”
Source: TD Securities. Click on the image for a closer inspection.