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USD/CAD: Loonie Set For Fifth Week of Gains on Higher Crude Oil Prices; BoC Eyed

By:
Vivek Kumar
Published: Oct 22, 2021, 14:56 UTC

“The CAD has accumulated a modest gain against a generally mixed to slightly softer USD this week.  Underlying fundamental drivers remain positive for the CAD, as our fair value model highlights, but correlations with spot are weak, indicating that the CAD is not getting as much lift as we might expect from firm crude and wide, short-term yield spreads. However, a more nuanced view of fair value, which takes more account of the USD’s performance, still suggests there is some decent value in the CAD and indicates an equilibrium nearer 1.2250,” noted Shaun Osborne, Chief FX Strategist at Scotiabank.

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The Canadian dollar strengthened against its U.S. counterpart and poised for a fifth weekly rise on Friday as surging crude oil prices continued to support the commodity currency.

Today, The USD/CAD fell to 1.2319, not far from the nearly four-month high rate of 1.2287 hit yesterday – from Thursday’s close of 1.2364. The Canadian dollar gained about 2.7% so far this month after depreciating around 0.5% in September.

USDCAD upside potential remains limited amid CAD-supportive spreads and commodities. The CAD has accumulated a modest gain against a generally mixed to slightly softer USD this week. Underlying fundamental drivers remain positive for the CAD, as our fair value model highlights, but correlations with spot are weak, indicating that the CAD is not getting as much lift as we might expect from firm crude and wide, short-term yield spreads,” noted Shaun Osborne, Chief FX Strategist at Scotiabank.

“However, a more nuanced view of fair value, which takes more account of the USD’s performance, still suggests there is some decent value in the CAD and indicates an equilibrium nearer 1.2250.”

Investors will closely watch the Bank of Canada’s next monetary policy decision, which is scheduled for October 27.

“Next week’s Bank of Canada policy decision (complete with an updated Monetary Policy Report) is the highlight of the Canadian calendar.  The policy decision at 10ET will be followed by Governor Macklem holding a press conference at 11ET.  This will all be a delicate balancing act for policymakers,” Scotiabank’s Osborne added.

“We expect a further tapering decision, a move to the reinvestment phase (maintaining stimulus but not adding to it) and a relatively constructive economic outlook.  Recent data reports (jobs, inflation and the Business Outlook Survey) have encouraged markets to price in a more aggressive policy tightening path next year.”

Canada is the world’s fourth-largest exporter of oil, which edged higher on supply and storage tightness. At the time of writing, U.S. West Texas Intermediate (WTI) crude was trading 0.61% higher at $83.0 a barrel. Higher oil prices lead to higher U.S. dollar earnings for Canadian exporters, resulting in an increased value of the loonie.

The dollar index, which measures the value of the dollar against six foreign currencies, was trading 0.20% higher at 93.578. The U.S. dollar has gained across most currencies in the last few weeks as investors have become concerned the Fed may withdraw its economic support due to slow global growth and high inflation.

“We think the recent dollar correction has worn off, and we expect a re-emergence of inflation and monetary tightening concerns to lay the ground for new USD strength. Today, we could see some stabilisation in G10 FX as a Powell speech and EZ PMIs may not offer reasons for directional trades. Elsewhere, we see split chances of a 25bp or 50bp rate hike in Russia,” noted Francesco Pesole, FX Strategist at ING.

Investors were concerned that increasing inflationary pressures could pose a headwind to the economy and affect how soon the Federal Reserve may be able to raise rates. Rising bond yields have contributed to the strengthening of the currency.

It is highly likely that the world’s dominant reserve currency, the USD, will rise by end of the year, largely due to the expectation of at least one rate hike next year. With the dollar strengthening and a possibility that the Federal Reserve will raise interest rates earlier than expected, the USD/CAD pair may experience a rise.

About the Author

Vivek has over five years of experience in working for the financial market as a strategist and economist.

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