USD/CAD sharply off sub-1.3050 lows weekly as DXY pairs losses, but bearish bias remains

• USD/CAD has seen a sharp move higher in recent trade from weekly lows below 1.3050 to current levels in the 1.3080s.
• Driving the move has been a recovery in USD; DXY has risen to 92.40 from lows of the day around 92.20.
• DXY’s recent rebound is most likely just a dead cat bounce, amid profit-taking after five days of losses.

USD/CAD has moved sharply higher in recent trade from weekly lows under 1.3050 to the 1.3080s, though recent gains have only been enough to take the pair back to trading flat on the day. The recovery has been driven by a pick up in USD strength that has seen the Dollar Index (DXY) bounce from lows of the day just above 92.20 to current levels close to 92.40.

USD/CAD to continue to be driven by USD, risk appetite

The US stock market sold off slightly into Wednesday’s US cash close, a move which was part technical, part fundamentally driven (S&P 500 futures short-term trendline support as New York announced the closure of schools). The move triggered some USD buying interest.

But broadly speaking, US equities continue to trade relatively close to all-time highs and USD continues to trade significantly lower on the week so far; CAD has been a beneficiary of this risk on/weaker USD combo, hence why USD/CAD still trades with losses on the week. What happens with USD and other asset classes (namely crude oil and stocks) continues to be the most important factor for CAD going forward, although Canadian retail sales numbers on Friday will steal attention for a short period of time.

But as many have noted, and Wednesday’s US stock market sell-off serves as a reminder of, near-term pandemic risks are rising with the US increasingly heading back into lockdown and markets might not have fully priced this in yet. If that is the case, further USD gains could lay ahead.

However, amid the increasingly dovish tone of the Fed and ongoing uncertainty regarding what outgoing US President Donald Trump might or might not do prior to his leaving office in January (and it is not even 100% yet that he will!), there are reasons to remain pessimistic USD.

In more detail, here are a few reasons why USD has struggled this week;

1) Pandemic - Regarding the pandemic, USD has seen minor strength in wake of recent vaccine updates, but these bouts of strength (seemingly driven by higher US yields at the time) have proven short-lived. Perhaps that is reflective of markets focusing more on the long-term economic impact of a faster global immunisation programme (sooner end to pandemic, faster recovery in 2021). If that implies stronger global growth relative to US growth in 2021, then vaccine news is actually more likely to end up a USD negative, some participants may argue. Meanwhile, the major economy seeing the worst deterioration in its economic outlook right now due to Covid-19 is the US (New York just announced the closure of schools), given that Asia is doing ok and Europe is already in lockdown and seeing Covid-19 numbers stabilise. Another reason not to favour USD.

2) US Politics - Markets are highly confident that Joe Biden will be President as of 21 January, even though the result has not yet been certified amid the Trump Administration's lawsuits and fraud claims. With the President seemingly more focused on trying to hold onto the Presidency in 2020 which he almost certainly seems to have lost, markets are concerned he might “run amok” in his final weeks and there are already reports pointing to this; last week President Donald Trump was reportedly talked out of authorising a military strike on Iranian nuclear facilities that could have sparked a conflict in the region. Such US political uncertainty might undermine the US dollar’s desirability as a safe haven.

3) Central Bank Divergence - The BoE and RBA have already just eased monetary policy, the BoC, BoJ, PBoC and RBNZ are all on hold and, given very clear guidance that more easing is coming in December, markets largely now price in the coming ECB “bazooka”. Meanwhile, no one is quite yet sure what the Fed is going to do in their December meeting; FOMC speakers (including Fed Chair Powell and Vice Chair Clarida) have all signalled increasing concern for the US economy over the coming months give the worsening virus situation. All have reiterated that emergency liquidity and financing facilities, as well as easy policy, are not going anywhere, but clear signals of what further measures might be on the horizon are yet to come. Thus, if the FOMC is to enact further economic supportive measures over the coming months, USD might yet need to see some further downside in order to price this in.

USD/CAD still within bearish trend channels

USD/CAD continues to trade within the confines of its recent downwards trend channel, bound by the downwards trendline linking the 1, 13 and 17 November highs to the upside and supported by the trendline linking the 5 November highs and 16 and 18 November lows to the downside (see the four-hour chart below).

Thus, USD/CAD’s near-term bias continues to look somewhat bearish, with a test of 1.3000 in the coming days still seemingly representing the path of least resistance. If the USD bulls are able to regain some composure, USD/CAD could break to the upside of this trend channel, opening up the door for a test of this week’s highs just above 1.3110, the pair’s 21-day moving average (DMA) at 1.3143. Beyond that, there is further resistance in the form of last week’s highs at 1.3170 and the 50DMA, which sits right on the psychologically important 1.3200 round number.

USD/CAD four-hour chart