USD/CAD Monthly Fundamental Forecast – September 2016

The USD/CAD closed the month at 1.3128 and is a strong buy moving into September with oil prices due to continue falling and the US dollar gaining momentum. Gold is easing down leaving no support for the CAD. Virtually stagnant domestic consumer demand in the past couple of months has deprived the Canadian economy of one of the most reliable sources of support in the past few years at a time when other sources of growth (business investment, manufacturing and the energy patch) continue to struggle. A contraction in Q2 GDP is very likely and the weak backdrop suggests a small dip in growth would have been likely, even without the impact of the Alberta wildfires.

The financial crisis has underscored the importance of markets to financial stability. The impact of the global financial crisis that began in 2008 varied across market products, both within the broader financial market spectrum and within the foreign exchange (FX) arena itself. That said, work is underway globally to identify opportunities to reinforce the resiliency of many markets, including FX. FX markets are central to the financial system, providing a means for funding foreign currency obligations, for hedging FX risks and for other services that enhance financial system efficiency. Canada is the 11th largest FX market by average daily volume and the Canadian dollar (CAD) is the 7th most traded currency in the world.

The Target for the Overnight Rate is the main tool used by the Bank of Canada to conduct monetary policy—for this reason, it is also known as the policy interest rate. It tells major financial institutions the average interest rate that the Bank wants to see in the market where they lend each other money “overnight.” When the Bank changes the Target for the Overnight Rate, this change affects other interest rates in the economy.

Canada’s major financial institutions routinely borrow and lend money overnight among themselves, in order to cover their transactions at the end of the day. Through the Large Value Transfer System (LVTS), these institutions conduct large transactions with each other electronically. At the end of the day, they need to settle with each other. One bank may have funds left over, while another bank may need money. The trading in funds that allows all institutions to cover their transactions at the end of the day takes place in the overnight market. The interest rate charged on those loans is called the overnight rate.

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