USD/CAD testing 1.2600 to the downside as USD comes under pressure

• USD/CAD is testing 1.2600 to the downside as USD comes under pressure.
• The loonie is a surprise underperformer on Monday despite strength in crude oil prices.

USD/CAD has largely traded as a function of USD sentiment on Monday, swinging to early European session highs of just above 1.2650 to then reverse back under the 1.2600 level on tandem with a reversal seen in the broad USD against its other G10 rivals. That reversal can be summed up in the Dollar Index (DXY), which rose to highs of above 90.50 early on in the European session but has since dropped back to test the 90.00 level, its lowest in over a month.

Choppy USD price action comes despite a nervous feel to US equity market trade (big Tech and semiconductor names are being hammered, dragging the Nasdaq 100 and S&P 500 into the red) and despite recent upwards moves in US bond yields; US 10-year TIPS yields have moved above -0.8% on Monday, up about 2bps since last Friday and up over 20bps since the start of last week.

While the likes of AUD, GBP, NZD, EUR and JPY are all key beneficiaries of this weaker USD, the loonie has not been able to garner much impetus, as the key 1.2600 support level in USD/CAD prevents further depreciation for now. On the day, the pair is down just 0.1% or just over 10 pips, despite the DXY having lost 0.4%; USD traders are perhaps anticipating dovish Fed speak from Fed Chair Jerome Powell (speaking Tuesday) and Fed Vice Chair Richard Clarida (speaking Wednesday), though higher US bond yields do not tell this same dovish story.

Loonie languishes inexplicably

Turning to the loonie side of the USD/CAD equations; it is not clear from a fundamental viewpoint why CAD has put in a somewhat soft performance on Monday versus many of its G10 counterparts, as there has not been any key domestic fundamental developments of note out of Canada. The only Canadian economic event of note this week will be a speech from Bank of Canada Governor Tiff Macklem on Tuesday. As is the case with Fed speakers this week, his comments will be watched in the context of recent bond market moves; Canadian bond yields have seen a rally of a similar magnitude to US bond yields since the start of last week or so; on 12 February, the Canadian 10-year yield was pretty much bang on 1.0%. As of today, it trades a few basis points to the north of 1.20%. This, combined with the continued strong performance of crude oil markets, helped CAD last week, though not so much this Monday.

Since the start of last week, the loonie is the fourth-best performing G10 currency, up 0.76%, behind AUD (up 2.0%), GBP (up 1.7%) and NZD (up 1.6%). Its performance has been hampered by an underwhelming retail sales number for December, released at the end of last week and the country’s sluggish Covid-19 vaccine. On that latter point, Capital Economics assumes that “there does not seem to be much chance of the coronavirus restrictions being lifted any sooner than around the middle of second quarter”. This compares to Australia and New Zealand who both currently have the virus under complete control and there are not under any restrictions and with the UK, whose rapid vaccination effort implies it will be able to reopen its economy more quickly and aggressively from Q2 onwards.