USD/CAD Weekly forecast: Fed promise trumps BOC pause

• BOC’s decides to delay rate hike five weeks.
• Fed inflation program and BOC timing bolsters USD/CAD.
• WTI trades to the highest since October 2014 on Friday.
• FXStreet Forecast Poll is neutral in the near term, slightly negative farther out.

Despite hints and considerable market speculation to the contrary, the Bank of Canada left its base rate at 0.25% at Wednesday’s meeting giving the USD/CAD the first of two major bursts that day. The second came in the afternoon as the Federal Reserve all but promised a rate hike at the March 16 meeting. 

For the week, the USD/CAD rose 1.5% to 1.2773, its highest close since December 29 but only marginally above its finish at 1.2766 on January 5.

The Canadian central bank did signal that it will begin a series of increases at the March 2 meeting by dropping its forward guidance for the current 0.25% rate, extant since March 2020. Canadian inflation was at a 30-year high of 4.8% in December. The Bank of Canada (BOC) core rate was 4%, much higher than the 3.5% forecast and November’s 3.6%. Consumer prices are forecast to rise 4.2% in 2022 in the bank’s new estimate. The prior projection in October was 3.4%. The economy is expected to expand 4% this year, down from 4.3% previously. 

The Federal Reserve’s inflation activism was encapsulated in the statement accompanying the decision to leave the fed funds rate unchanged at 0.25% and to end the bond purchase program in March. “With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.”  

Markets take the Fed’s "soon" to mean March 16, not the following meeting on May 4. The bank also issued guidelines, though not dates or amounts, for reducing its $9 trillion in assets, a balance sheet that has doubled in the last two years. 

Fed Chair Powell’s remarks in his press conference reinforced and expanded the case for higher rates. 

“I think there’s quite a bit of room to raise interest rates without threatening the labor market,” was one of many Powell responses in the hour-long question and answer with reporters' that elicited immediate reactions from traders in the equity, credit and currency markets. 

A barrel of the North American oil standard rose 2.39% this week closing at $86.66 on Friday.  From its most recent low on December 1 at $65.01, West Texas Intermediate (WTI) has jumped exactly one-third, 33.3%.

Energy prices and WTI specifically, have been a restraining force on the USD/CAD since their recovery began in December. The energy sector underlies about 10% of Canadian economic activity.  

This benefit to the Canadian economy is the chief reason the USD/CAD remains well below its 2021 high of 1.2964 while the euro fell to an 18-month low on Friday at 1.1121, and is down 1.99% year-to-date. The AUD/USD and the NZD also set new 18-month and 16-month lows Friday and are off 3.70% and 4.32% against the dollar this year.

The BOC decision was the only market event for Canada this week.  

In the US, third quarter Gross Domestic Product (GDP) on Thursday was much stronger at 6.9% than the 5.4% forecast. This gave the dollar an additional boost as it suggested the performance of the economy had a better base to start the New Year. Durable Goods were weaker than predicted in December though November’s results were revised markedly higher. Jobless claims fell back from their 13 week peak on January 14, but the four-week average remained at a two-month high. Rising unemployment claims have been carefully watched for signs that the US economy is slowing.  

Inflation scored another record for the Personal Consumption Expenditure Price Index (PCE) in December with 4.9% for core and 5.8% for the overall. Personal Income rose 0.3% in December, missing the 0.5% forecast and Personal Spending dropped 0.6% as expected.  

USD/CAD outlook

Despite the general improvement in the US dollar this year, its prospects against loonie are limited for two fundamental reasons. 

First, the Fed’s rate campaign will be matched by the BOC. A glance at the respective bond returns this year tells the story. On December 31 the US 5-year Treasury yield had a 0.1 basis point advantage on its Canadian counterpart. At Friday’s close the Canadian yield had edged ahead by 0.8 basis points. In the 10-year notes, the US went from an 8.2 basis spread at the end of the year to a 1.9 point spread on January 28. 

The inflation and rate policy in Ottawa is the same as that in Washington. Inflation differentials between the two economies can be ascribed to the much more aggressive fiscal and monetary stimulus provided in the US by the federal government and the Fed.    

The second reason for the Canadian dollar’s resilience is oil. In the 15 months since November 2, 2020, WTI has gained 142%; since January 1 last year the increase is 79%. This year WTI is up 14%. Canada has not restricted its energy industries. Whereas, the US in the last year has gone from oil independence and exporting energy to importing crude at the much higher global prices, that its own shale drillers had formerly done so much to restrain. The benefits of the energy sector to the Canadian economy and the loonie are substantial.

Canada’s Net Change in Employment and Unemployment Rate are the chief economic news in the week ahead. As always, its own report will be of less import for the Canadian dollar than the US payrolls issued at the same time. Part of the reason is that Canada rehired the last of its lockdown unemployed back in October while the US is still several million short of reconstitution. 

In the US, Nonfarm Payrolls for January and Purchasing Managers Indexes are the main events. Job creation is expected to be modest at 200,000, in line with the two previous months.  Any improvement would support Treasury rates and the dollar. The unemployment is expected to remain at 3.9%,

The March 2020 to June 2021 decline in USD/CAD is unrecovered. The current USD/CAD is a bit less than mid-way between the 23.6% and 38.2% Fibonacci retracement levels. Last month saw the closest approach to the 38.2% line at 1.2978 when the USD/CAD traded to 1.2964 on December 20. The inability of the USD/CAD to recapture ground in the seven months since the bottom and at a time when the US dollar has prospered is indicative of the inherent strength of the Canadian economy. 

The immediate bias in the USD/CAD is neutral as the rise in US Treasury rates has stalled, the Fed policy shift is now priced and questionable global growth in the first quarter should cap WTI.

The possibility that the Fed would accelerate its tightening schedule had been the driver of the US dollar and the USD/CAD over the past two weeks. The March inception is established and there are not going to be any changes in US policy outlook for the next five weeks.  A deterioration in the US economic situation could call the Fed move into question, but it would take a serious downturn to make the governors change their minds. 

The BOC meets on March 2 with a 0.25% hike expected, but that has been long priced. When it arrives it could generate a negative reaction in the Canadian dollar if speculation over the next five weeks runs to a 0.5% increase.

Canada statistics January 24–January 28

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US statistics January 24–January 28

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Canada statistics January 31–February 4

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US statistics January 31–February 4

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USD/CAD technical outlook

The MACD (Moving Average Convergence Divergence) cross of the signal line on Monday and the turn higher on January were effective indicators for the subsequent USD/CAD gains. The Relative Strength Index (RSI) has moved into positive territory and Average True Range (ATR) volatility has reached its highest since mid-October last year. All of these indicators have reacted favorably several times in the past seven months without predicting a lasting reversal or trend higher. This time is likely to be no different. 

Resistance: 1.2800, 1.2830, 1.2860, 1.2900, 1.2940

Support: 1.2750, 1.2715 (50-day moving average), 1.2675, 1/2625 (23.6% Fibonacci 1.2618, 21-day moving average 1.2627, 100-day moving average 1.2625), 1.2600

FXStreet Forecast Poll

The FXStreet Forecaast Poll sees balanced inputs for the USD/CAD out to one quarter even with the Federal Reserve's new inflation policy.