USDCAD: The big short redux? – TDS

USDCAD’s relentless grind lower persists and has now neared a very significant pivot area of 1.2450/60, which marks the May 3rd 2016 bottom and an appreciable break below this would signal another meltdown risk in USDCAD that would put 1.2000/50 as the next major downside attractor and broadly in line with the 50% Fibo retracement of the entire bull market run established from 2011, according to Mazen Issa, Senior FX Strategist at TDS.

Key Quotes

“While we think the 1.2450/60 area will act as formidable support, we cannot dismiss the risk of another significant move lower. The narrative we have heard thus far is that USDCAD has come a long way. Indeed, a slew of standard technical measures—such as the RSIs—suggest that this is indeed the case. While we broadly agree with this premise, it is not unusual for USDCAD’s correction to run deep; see the January 2016 episode for example though it is worth noting that USDCAD did not rally as much to local peak. Further, data according to CFTC suggests that positioning is closer to neutral, leaving extension risk lower a non-trivial matter still.”

“While we think a lot of good news is baked into the CAD-leg, we see little in the way of a catalyst to trigger a significant repricing to generate material USDCAD topside. This is particularly the case on the rates/BoC outlook as the data continues to perform. The latest rhetoric was yet another game changer from an FX perspective. We believe the BoC has created an asymmetric risk profile around the CAD by noting that near-term softness in inflation would be transient; in doing so, the Bank has created a buffer to tolerate inflation disappointment (at least for the coming quarter). Taken in conjunction with cleaner positioning suggests USDCAD rallies will lack bounce. 1.2700 acts as the first resistance point while the 1.2850/1.2900 area would have us reconsider fresh shorts.”

“Thus, we see the greatest risk stemming from the USD leg. The USD backdrop remains challenged still, and has been exacerbated by persistent challenges facing the Trump administration. Further, the market has assumed a very benign outlook for the Fed. Soft inflation has also added credence to this view, which we acknowledge could delay our expectation of another hike in December. We think it is too soon for the Fed to adopt a more explicit dovish outlook on inflation this week, but an acknowledgement here could be the domino that tests USDCAD through key supports.”

“We note however that the market has now priced in more cumulative tightening by the BoC than the Fed. We think this is a relative mispricing as it will be very difficult for the BoC to hike more than the Fed.”