Bank of Canada Preview: QE taper to pave the way for a stronger CAD

• Bank of Canada (BoC) is expected to reduce weekly asset purchases to C$2 billion.
•  A hawkish BoC policy outlook is likely to provide a boost to CAD.
• A daily close below 1.2425 could open the for additional USD/CAD losses.

The Bank of Canada (BoC) is largely expected to keep its policy rate unchanged at 0.25% following its July meeting. More importantly, the market consensus points to a reduction in the BoC's weekly net purchases of Canadian government bonds, quantitative easing (QE) program, to a target of C$2 billion from C$3 billion.

Incoming data show recovery is gaining momentum

Confirming the improving economic outlook, the BoC's latest Business Outlook Survey (BoS), which was published on July 5, revealed that the BoS Indicator advanced to a new all-time high of 4.17 in the second quarter from 2.95 in the first quarter. "The number of firms with improved indicators of future sales is at a record high, signalling broad-based strengthening of demand versus a year ago," the publication further read.

Meanwhile, the June jobs report from Canada revealed that the Unemployment Rate declined to 7.8% from 8.2% in May with the Net Change in Employment arriving at +230.7K, compared to analysts' estimate of 195K.

While testifying before the Senate's Banking Committee back on June 16, BoC Governor Tiff Macklem noted further adjustments to the QE program will be gradual and reiterated that they will be deliberate in the assessment of incoming data.

In case the BoC signals that it is planning to taper the weekly asset purchases further toward the end of the year on top of a reduction in July, this could be seen as a positive development for the loonie. On the other hand, the BoC could opt out to adopt a more cautious tone, note uncertainty around the recovery amid the spread of the coronavirus' delta variant and hurt the CAD.

USD/CAD outlook

Following the BoC's April meeting, the USD/CAD pair fell sharply and lost nearly 5% in two months to touch its lowest level since 2015 at 1.2007 on June 1. During that period, crude oil prices rose more than 12% and helped the commodity-sensitive loonie gather additional strength.

However, the hawkish shift witnessed in the US Federal Reserve's policy outlook triggered a USD buying wave in early June and kickstarted a decisive rebound in USD/CAD. Since early June, the pair gained 3% and seems to have steadied around 1.2500 ahead of BoC.

On the downside, the initial support is located at 1.2425 (Fibonacci 23.6% retracement of the June-July uptrend). If the pair manages to break below that level following a hawkish BoC statement, it could target 1.2380 (100-day SMA) ahead of 1.2350 (Fibonacci 38.2% retracement).

The initial resistance is located at 1.2500 (psychological level). A daily close above that level could open the door for additional gains toward 1.2555 (July 9 high) and 1.2590 (July 8 high). The 200-day SMA is currently located at 1.2625 and is likely to hold as a strong resistance even if the BoC refrains from signalling more QE reductions before the end of the year.