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USDCAD – 7 June 2023

Technical Analysis

On a year-to-date basis, USDCAD has traded firmly within a 4% range having appreciated from lows of 1.3261 on 2 February to highs of 1.3863 on 10 March – its highest level since October 2022. Following recent macro-economic developments (explored below) USDCAD now consolidates below 1.3400 with six out of the last eight trading sessions closing lower. This recent downside trend sees USD well below the 10-day simple moving average (SMA) of 1.3467 as well as the respective 20 and 100-day SMA of 1.35057 and 1.3514.

USDCAD finds short-term double-top resistance at 1.3670, having failed to break this level both in late April and in late May. With upside rallies failing to gather sufficient momentum here, trading sessions following attempts to break 1.3670 have seen considerable dollar sell-offs suggesting some profit taking. A breach of this figure would be an indication of bullish USDCAD momentum, and buoy market optimism on the prospect of a rally towards the 1.3800 level of resistance.

Medium-term trading also indicates support at 1.3300, though given how USDCAD is consolidating around the confluence of the lows of April and May, the trend line of higher-lows suggests some support may be present around 1.3330. As this pennant converges, an upside move out of this region would be bullish towards USDCAD as it follows the trend of dollar appreciation seen since mid-2021.

Markets Weigh on Bank of Canada Interest Rate Decision

On 7 June, markets reacted to the Bank of Canada raising their main policy rate by 25bps. This pushed the target for their overnight rate to 4.75%, marking its highest level in 22 years.

In March and April, the Bank of Canada met market expectations by leaving rates unchanged at 4.5%. Their decision in March marked the first major central bank in the West to cease further monetary tightening, with Ottawa citing inflation falling in line with expectation as the key influencing factor. The BoC also remains cognisant about the impact of an overly restrictive monetary policy on mortgages and the property market, which remains historically tight.

Furthermore, policy makers remain cautious over not wanting to adversely hinder the prospect of growth. Canadian GDP is expected to rise 1.5% over 2023 according to the IMF, though given the country’s vast commodities sector, any growth will be heavily contingent on global demand – not least from China whose growth this year is the subject of considerable debate.

Moreover, given global recessionary fears feeding into downward pressure on energy prices, much of Canadian growth remains contingent on wholesale energy prices particularly given that the sector accounts for nearly 10% of Canada’s total GDP and more than a fifth of their total exports.

While the BoC kept rates unchanged at their last two policy meetings, inflation shows signs of increasing further. For example, the annual rate of inflation rose 0.1 percentage points between March and April, bucking the trend of falling inflation seen since the recent 8.9% peak in June 2022. As such, their latest decision to raise rates shows hawkish tendencies, particularly given that prices rose 0.7% on a month-on-month basis between March and April.   

US Macro-Economic Analysis

The recent USD rally up to 31 May comes as investor optimism gathers momentum following the Biden-McCarthy deal averting the prospect of a technical default in the States. Crucially the Fiscal Responsibility Act suspends the debt ceiling through to 1 Jan 2025 – giving the US some breathing space as their debt obligations continue to soar and federal debt exceeds $31.47tn. While the fiscal tightening measures aim to reduces the government deficit by some $1.5T over next 10 years, the deal keeps intact much of Biden’s landmark Inflation Reduction Act which seeks to reduce inflationary pressures and mitigate against the prospect of a recession. Hence, while uncertainty around debt-ceiling discussions propagated a general risk-off sentiment, the passing of the Fiscal Responsibility Act has buoyed investor sentiment feeding into dollar strength.

Dollar strength has also come as a result of markets upward revising their rate hike expectations from the Federal Reserve. The release of the minutes from May’s meeting suggests while several of the FOMC may be inclined to ‘skip’ a rate hike in June, given that “many participants focused on the need to retain optionality after this meeting”, the possibility of further rate hikes remains. While markets in early January were pricing in a terminal rate of 5% (by June 2023), persistent inflation has seen this upwardly revised. For example, money markets are now pricing in 75% chance of rates hitting 5.5% by 26 July, with such revisions feeding into further dollar strength. Given the minutes’ emphasis on policy makers retaining optionality, much of this recent upward revision in rate expectations have been the result of fresh data pointing to further inflationary pressures.

With markets weighing on FOMC members’ policy inclinations being heavily data-dependent, recent economic indicators pointing to persistent inflationary pressures has seen markets rally towards the dollar. For example, on 1 June, the ADP Employment Change surpassed expectations of 170,000 having hit 278,000. Along with non-farms similarly beating forecasts (339,000 vs 170,000), markets assessed the impact that a persistently tight labour market would have on inflation and in turn, the FOMC’s appetite for a further rate hike. Notwithstanding marginally higher-than-expected unemployment and slightly softer wage-growth the DXY dollar index rallied 0.75% in the 12 hours following the US labour market print, as markets weighed on the possibility of a further hike.

The US labour market print came just a week after stronger-than-expected US Q1 GDP results (1.3% vs 1.1%), saw investors further rally towards the dollar. Here, consumer spending rose greater than forecasted, though investor sentiment remains cautious given that the print still marked the weakest growth since Q2 2022, and consumer confidence slipped in April and May.

While US labour data saw markets upwardly revise rate hike expectations from the Fed, the ensuing DXY appreciation was countered by rising oil prices which fed into considerable CAD strength. As such with WTI crude futures rising 7.4% between 1 and 5 June, USDCAD slipped over 1%.

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