The US Dollar to Canadian Dollar (USD/CAD) exchange rate has surged to 1.4240, extending a powerful rally that has carried the pair almost 5% higher since the start of May.
Scotiabank notes that the Canadian Dollar has endured a near relentless decline, losing ground against the US Dollar on around 80% of trading days since peaking near 1.3550 in early May.
The bank believes widening US-Canada yield spreads have been the primary driver of the move, although those spreads are now showing signs of stabilising.
According to Scotiabank, current rate differentials look increasingly stretched, with the implied US-Canada yield gap approaching 140 basis points in the one- and two-year sectors.
While the bank remains cautious about fighting the prevailing trend, it warns that USD/CAD has become heavily overbought. Scotiabank notes that the daily RSI has risen above 88, its highest level in at least two decades.
The bank acknowledges that the move above 1.41 opens the door to further gains towards 1.43 and potentially 1.45.
However, Scotiabank cautions that “the correction, when it comes, should be meaningful”, reflecting the extreme nature of the recent rally.
For now, the bank remains neutral-to-bullish on USD/CAD, but believes the risk of a significant Canadian Dollar recovery is growing as positioning and technical conditions become increasingly stretched.
