Canadian Dollar momentum is building as yield spreads narrow and crowded short-CAD positions come under pressure, with Scotiabank warning USD/CAD could extend its fall towards 1.3817.
The US Dollar to Canadian Dollar (USD/CAD) exchange rate closed Friday around 1.3875 after the Canadian currency finally pushed through an area that had frustrated several earlier attempts at appreciation.
USD/CAD fell 0.38% on Friday and almost 1% over August so far, leaving the pair close to its lowest level of the month.
Foreign exchange analysts at Scotiabank thinks there may be more to this move than a brief burst of commodity-currency strength.
The bank points particularly to interest-rate spreads, with the US/Canada two-year bond differential narrowing around 25 basis points since its late-July peak.
“Spread compression is a clear motivation for the CAD,” Scotiabank said, adding that the move has helped underpin recent Canadian Dollar gains.
There is also a positioning story developing.
Scotiabank analysts noted that the latest CFTC figures still showed “a very significant net speculative short CAD position”, leaving bearish Canadian Dollar (CAD) trades vulnerable as spot moves the other way.
In other words, the currency doesn’t necessarily need a dramatic improvement in the broader risk environment to extend the squeeze.
USD/CAD fell sharply late in the week, dropping from around 1.3950 to 1.3875 and finishing close to the bottom of its five-day range.
The bank’s latest fair-value estimate was around 1.3895, putting spot fractionally below that level even before Friday’s final push lower.
Scotiabank nevertheless argued that this “may not stop the CAD from squeezing out a little more strength in the short run.”
Short-Term USD/CAD Outlook: 1.3817 Comes Into View
The technical argument is considerably more bearish than the fair-value signal.
Scotiabank said USD/CAD’s inability to capitalise on its mid-week rebound, followed by renewed pressure on the 1.3899 area, “sustains the bearish outlook for the USD.”
That level represents the 50% retracement of the May-to-June Dollar advance.
More importantly, the bank now sees momentum moving in the same direction across several horizons.
“Trend momentum signals are aligning across short-, medium-, and (now) long-term oscillators now, supporting the prospect for a significant move lower to develop,” Scotiabank said.
A sustained move beneath 1.39 would put 1.3817, the 61.8% retracement level, in focus.
Beyond there, strategists at Scotiabank foresee the possibility of a return towards the much broader 1.35-1.37 region.
The three-month chart shows USD/CAD retreating sharply from its June peak above 1.42, with spot now below both its 20-day and 50-day moving averages.
The US Dollar still has clear levels at which the bearish case would begin to look less comfortable.
Scotiabank puts initial resistance at 1.3965/70, followed by firmer resistance around 1.4000/25.
But the immediate pressure is pointing the other way.
The Canadian Dollar has yield-spread support, speculative positioning that can still be squeezed and a USD-CAD chart that has started to break lower at the same time.
Scotiabank’s 1.3817 target is therefore no longer far away.
The more pertinent question is whether a break there turns the current CAD recovery into something much larger.
