Rangebound Loonie Ready to Breakout?

With WTI up 40% on the year and the economic data still resilient, at first glance it would seem strange that the Canadian Dollar hasn’t been able to make a stronger push higher this year.  Even though it’s up 3% and one of the better FX performers in 2019, that isn’t as good as it sounds.  The Loonie took a big dive to end Q418 above 1.3600, but this was an outlier for the year that clearly skews the data.  USD/CAD traders have their doubts about the Canadian economy even with the decent data, and this has resulted in relative stagnation since January.  But what exactly is the reason for skepticism?

Figure 1 - USD/CAD Sentiment (FXStreet)

Let’s start with NAFTA/USMCA.  The Trump Administration is pushing to have this ratified by August, but House Democrats have indicated that they are not prepared to sign off.  You can bet this will become a bigger confrontation as we head closer to summer.  Trump has shown himself to be volatile in these sorts of standoffs, and there is a strong possibility that Trump pulls the plug on NAFTA to put the squeeze on the House.  If that scenario plays out, the Canadian Dollar will be dumped across the board.  Even if the threat of this becomes real enough to spook traders, the downside risks to the Loonie cannot be understated. 

Figure 2 - USD/CAD Weekly (Netdania)

Traders are also looking at some of the Canadian data closely and seeing signs that the upside surprises are not indicative of the true health of the economy.  Take look at housing starts, which did prop up again in March to 192,000; however, they are still well below the 2018 average.   And with the 12-month rolling average declining for the ninth straight month, to 189,000, housing starts are on a clear downward trend.  New home sales have also been disappointing, which suggests housing starts will fall further.  With housing such a big part of the Canadian economy, this would stunt growth if the trend sustains.

Figure 3 - Canada Housing Starts in Downward Trend (Trading Economics/CMHC)

Finally, Loonie skeptics have been most spooked about the yield spreads between US 2-year and Canada 2-year notes, which historically has been a major driver of the USD/CAD exchange rate.  The chart below shows the US2YT (purple line) spread has widened over CA2YT (blue line) over the past few months, but we have not yet seen the corresponding move in USD/CAD (bar chart).  USD/CAD bulls are betting that this wont last long, and another run towards 1.3500-1.3600 is not out of the question. 

Figure 4 - USD/CAD vs US2YT/CA2YT (TradingView)

With all this being said, this week is packed full of key data points that will dictate the short-term direction of the Loonie.  We are seeing broad USD weakness to start the week, as well as better over risk sentiment.  CAD bulls will be hoping for continued upside surprises on the data, which could send USD/CAD into the 1.3200 territory for a short period of time.  But given the long run factors at play, many traders would see this dip as a USD/CAD buying opportunity rather than a longer downtrend. 

Here are the key events this week that will drive USD/CAD:

Figure 5 - US/Canada Key Events (FXStreet)