USD to CAD Price Forecast: Lower after BoC Raises Rates, US Inflation Slows

Highlights

• CAD strengthens after unexpected 25 basis-point rate hike by BoC.
• USD weakens as US CPI shows slowest inflation rate in over two years.
• Market sentiment shifts with traders feeling comfortable shorting USD.

Overview

The USD to CAD is trading lower on Thursday, hovering just above a two-week low reached the previous session, as the Bank of Canada (BoC) implemented a 25 basis-point rate hike, reaching a 22-year high of 5.0%. This unexpected move provided a boost to the CAD, catching the market off guard. Meanwhile, the USD faced broader weakness following the release of soft US Consumer Price Index (CPI) data, which showed the slowest inflation rate in over two years.

BoC Rate Hike Boosts CAD

The BoC’s decision to raise interest rates was driven by concerns that inflation could surpass its 2% target. This move further fueled the CAD’s rise. Additionally, the USD declined against major currencies, and the price of oil, a significant Canadian export, increased in response to the US inflation data. These factors combined to strengthen the CAD and raise hopes that the Federal Reserve (Fed) might be nearing the end of its monetary tightening cycle.

US Inflation Falls Below Expectations

The recent US core inflation figure for June came in at 0.2%, falling short of market expectations of 0.3%. Furthermore, the annual CPI dropped to 3% after peaking at 9.6% a year earlier. This downward trend suggests that the previously high inflation levels are subsiding. The market increasingly doubts the likelihood of another Fed rate hike following the July 26 meeting.

Traders Comfortable Shorting US Dollar

Traders have become more comfortable shorting the U.S. dollar (USD), indicating a qualitative shift in market sentiment. The recent underperformance of the USD is seen as a reflection of this change. As the terminal Federal Reserve policy rate appears to be increasingly capped, traders are adjusting their positions accordingly. While interest rate futures indicate that a rate hike by the Fed later this month is fully priced in, expectations for any further increases are being scaled back. This growing comfort in shorting the USD has contributed to its weakness against a basket of major currencies including the Canadian Dollar.

US, Canadian Yields Tumble

As a result, two-year Treasury yields, which correlate with rate expectations, experienced a significant overnight drop of over 15 basis points, settling at 4.73%. Canadian bond yields followed the movement of US Treasuries, causing a decline across the yield curve. The 2-year Canadian bond yield fell by 13.7 basis points to 4.668%, while the spread between Canadian and US yields narrowed by 1.5 basis points to 7.6 basis points, favoring the US.

Short-Term Outlook:  Bearish Tone

In conclusion, the USD to CAD exchange rate neared a two-week low as the Bank of Canada raised interest rates and US inflation eased. The CAD gained momentum from the surprise rate hike, while the USD weakened in response to lower than expected US CPI figures. Market sentiment suggests doubts about future Fed rate hikes, leading to a decrease in confidence for shorting the USD. Overall, the outlook for the CAD remains bullish in the short term, while the USD faces bearish pressure due to the shifting market dynamics.

Technical Analysis

USD to CAD market sentiment is bearish as the current 4-hour price of 1.3159 is below the previous 4-hour close of 1.3176. Additionally, the price is trading below both the 200-4H and 50-4H moving averages, indicating a downward trend. The 14-4H RSI of 28.12 suggests an oversold condition, possibly leading to a rebound.

The main support area at 1.3142 and 1.3118 is within striking distance, while the main resistance area is between 1.3360 and 1.3384. With the price below both support and resistance areas, the market is inclined towards further bearish movement in the near term. Watch for a possible technical bounce following a test of the support zone, due to the oversold conditions.