USD/CAD drops towards 1.2650 amid risk on markets

• USD/CAD has dropped from early European session levels around 1.2700 to current levels just above 1.2650 amid risk-on markets.
• Bond markets are calming down, allowing markets to refocus on the positive macro backdrop of stimulus, vaccine rollouts and falling Covid-19 cases.
• Looking ahead, Canadian GDP will be the main focus for USD/CAD on Tuesday.

Having hit two-week highs at close to the 1.2750 mark last Friday, USD/CAD is seeing a sharp pullback on the first trading day of March. The pair currently trades in the 1.2650s, down about 0.7% or roughly 85 pips on the day. Much of the drop has occurred in the last few hours; USD/CAD was trading around the 1.2700 mark as recently as shortly after the open of European trade. With the pair having dropped below its 21-day moving average (which currently resides at 1.26947), a break below support at the 1.2650 mark (last Monday, Tuesday and Thursday’s highs) would open the door to a run at the psychological 1.2600 level.

Driving the day

A risk-on market tone combined with broad strength in commodity prices are the main reasons as to why the loonie is outperforming on Monday (along with AUD and NZD); US equities are trading firmly in the green (S&P 500 +2.2%), while crude oil markets (WTI +0.5%) are also firmer, though a tad choppier ahead of this week’s OPEC+ meeting. Bond market volatility appears to be easing, so allowing markets to focus on positive macro developments in the US; the FDA gave J&J’s vaccine Emergency Use Authorisation, setting the stage for an acceleration of the country’s vaccine rollout and US hospitalisation fell below the 50K mark for the first time since last November. Meanwhile, the House of Representatives voted in favour of US President Biden’s $1.9T stimulus package (as expected), sending the bill to be voted on in the Senate.

Turning to factors more specific to the USD/CAD cross; Canadian Current Account data for Q4 2020 was released at 13:30GMT and came in a little better than expected; the difference in the value of exported and imported goods, services and interest payments in the Canadian economy came in at CAD -7.3B, a little higher than expectations for CAD -8.3B and above Q3’s reading of CAD -10.5B. Meanwhile, Markit Manufacturing PMI for the month of February saw a slight improvement to 54.8 from 54.4 in January, consistent with the notion that global manufacturing conditions remain (for the most part) positive.

In terms of US data, the final Markit Manufacturing PMI headline index number for February saw a slight revision higher to 58.6 from 58.5 and Construction Spending in January grew at a slightly faster MoM pace of 1.7% versus expectations for a MoM growth rate of 0.8%. These data points have largely been ignored, however, with market participants much more focused on the February ISM manufacturing survey.

The headline ISM Manufacturing PMI number came in above expectations at 60.8 (expected was 58.8), its highest since September 2018. The employment subindex rose to 54.4, boding well for this week’s official US labour market report. New Orders rose to 64.8 from 61.1, in a sign of strong demand ahead. But the Prices Paid subindex shot higher to 86.0, its highest level since 2008. According to Capital Economics, “higher oil prices and the depreciation of the dollar are putting some upward pressure on US prices this time around too, but the scale of the rise in the ISM prices paid index goes well beyond what can be explained by those factors alone”. The economic consultancy continues that “the comments in the report also make it crystal clear that these shortages go well beyond just semiconductors, with firms in every sector reporting shortages and problems with suppliers keeping up with demand”.

Looking ahead, things are set to be quiet in terms of scheduled economic events out of the US and Canada for the rest of the session. But stimulus and pandemic headlines will be worth watching. On Tuesday, focus will turn to the first estimate of Canadian GDP growth in Q4 2020 (expected to come in at an annualised rate of 7.5% QoQ). Note that consensus market expectations for growth in Q4 are well above the Bank of Canada’s growth projection of 4.8%.