Wednesday, September 9, 2020

The Canadian loonie may have some downside potential on today’s BoC monetary policy decision

Tags
  • Dollar
  • Oil
  • CAD
  • Bank of Canada

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Analysts’ Pick: The Canadian loonie may have some downside potential on today’s BoC monetary policy decision

  • The Canadian economy has recovered faster-than-expected, giving little reason for the BoC to ease policy further
  • Optimism from the central bank may be limited by a likely reiteration of significant downside risks due to a number of factors including a stalling global economic recovery and growing uncertainty
  • Oil prices may continue to put downside pressure on the Canadian dollar in the short-term as well as energy demand remains a key concern for oil traders
  • The greenback’s upward momentum continues to appear as a consolidation, signalling that upside may still be limited to the short-term

Bank of Canada's (BoC) rate decision today shouldn't surprise much, as policy is expected to remain on hold in the near future. The Canadian economy has rebounded at a faster-than-expected rate and we expect the BoC to touch on this, while adding that risks for the economy remains tilted to the downside, with high levels of uncertainty surrounding the global economic recovery and the Covid-19 pandemic.

Canada’s continues to show progress in its economic recovery

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With the Fed's surprising explicit shift to average inflation rate targeting, we may see the BoC signal a similar as well. But any concrete specificity is unlikely at today's meeting, since the BoC is still in the middle of its own framework review that will only end next year. As a result, we probably will only get signals of changes to come, which we expect should be something similar to what the Fed has been shifting towards. As with the ongoing theme with central banks of other developed economies, the BoC is likely to err on the side of caution as well, and not tighten policy too early. In terms of asset purchases, this means that the pace of 5 billion per week for government bonds is likely to be maintained.  The reason for this is due to the uncertainty regarding the pandemic as well as the timeframe and availability of a vaccine for the novel coronavirus in future. Data shows that Canada has relatively been able to control the spread of the virus domestically, although yesterday's data showed a spike in new cases, the most since May. Global data also suggests that a resurgence in Covid-19 cases is only a matter of when, not if and central bankers will likely take this into account. Important to note is that although governments at this point will likely be unwilling to reimplement strict lockdown restrictions, people's behaviour will still be impacted due to fear and uncertainty which will likely have a longer lasting effect on the economy.’

Canada’s pace of daily new cases has started to show signs of acceleration

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Oil prices should continue to put downward pressure on the currency as well, as the recovery in energy demand remains questionable in the short-term. We have already seen the most recent dip in oil prices erase roughly three months’ worth of gains and it does appear likely that upside is limited in the short-term due to seasonal changes in the US reducing the demand for gasoline, as well as a stalling global economic recovery. Canada's oil exports also remain highly reliant on the US (in 2018, 96% of Canada's oil exports went to the US), who has also shown signs of its economic recovery stalling. The declining oil prices will probably tilt the Canadian dollar towards the downside as the outlook for oil prices will be limited at the moment since overconfidence in a recovery in energy demand as well as possible over-optimism on a vaccine for the novel coronavirus.

Spread between WTI Dec 20/Dec 21 contracts widen the most since May

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As a result, we expect the Canadian loonie to have little impact from the central bank with risk for the currency a limited downward movement as the BoC may appear more dovish due to uncertainties resulting from the most recent spike in daily Covid-19 cases domestically. CAD/USD may as a result retest the 0.7527 level later today on the BoC's decision and as we view the dollar's rebound to continue in the short-term. Over the medium-term however, there may be some room upside for the Canadian dollar as even with the latest spike in cases in the country, its average daily positive rate still remains below 5% (the recommended rate by the WHO). The dollar also appears to be in a consolidation cycle instead of a strong rebound back into levels seen earlier in the first half of the year, which signals that the dollar's upside may be limited in the short-to-medium-term. As a result the medium-term outlook for the CAD/USD may be for a rebound back higher towards 0.7612's level but at a more gradual pace than before.

Technical Analysis:

CAD/USD

CAD/USD has held on to a strong bullish since the end of March and has recently started to show signs of consolidation – something we view as necessary to maintain a healthy bull run. The currency pair hasn’t appeared to materially enter into a long-term bearish trend and still appears to still be a distance from doing so as it still trades well above the 50-day moving average line. We view 0.7499 as a key support in addition to the 50-day moving average as an indicator for a move into bearish territory. We may likely see the Loonie retest the 0.7527 support soon, possibly during the BoC’s monetary policy decision announcement in addition to pressure from greenback bulls due to residual momentum in the short-term. Over a longer-time frame, fundamentals still skew the Canadian dollar towards the upside against the greenback, but this can quickly switch due to the high levels of uncertainty stepping into the next quarter of the year.

Support: 0.7527 / 0.7499 / 0.7467

Resistance: 0.7612 / 0.7642 / 0.7676

CAD/USD Chart (H4)

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