USD/CAD: Downgrade to Canada’s rating highlights risks to CAD’s outlook – MUFG

Analysts at MUFG Bank turned their attention to to the Canadian dollar given the notable decision taken on Wednesday by Fitch to downgrade Canada’s sovereign credit rating from AAA to AA. They expect the Canadian dollar to rise versus the greenback, and to underperform other G10.

Key Quotes:

“As with other downgrades this has had limited impact on CAD performance and at a time of unprecedented fiscal deficit blowouts, it hardly seems fair to single Canada out by selling CAD. But the decision does in our view help to highlight a differentiating factor that could well mean a more muted form of economic rebound from the COVID crisis going forward.”

“The performance of CAD may well also be impacted by the scale of stimulus being implemented by the BoC. The assets on the balance sheet due to the numerous asset purchases undertaken along with reop operations have surged from CAD 120bn to CAD 500bn – more than a fourfold increase and in GDP terms equating to about 17%.”

“Correlation analysis tells us that CAD is currently being influenced more by equity market performance than by oil price movements – hence overall risk sentiment will be important. But crude oil price direction is still important. Our oil analyst in Dubai has a constructive view for oil over the medium term but the rally to date may mean some short-term corrections lower as increased demand works through a still large inventory overhang. Furthermore, COVID risks rising in the US need to be monitored as a risk factor for CAD given the obvious proximity risks for Canada. 

“Short-term we see scope for the USD to correct stronger which would likely see renewed CAD weakness. But further ahead when we expect USD to weaken, we still see reason to forecast CAD strength versus USD lagging other G10 currencies.”