The Bank of Canada is about to end its monetary tightening cycle, which sets back the USDCAD even amid the rise in the oil market. Should one sell the loonie versus major currencies? Let’s discuss the market outlook and make up atrading plan.
Monthly Canadian dollar fundamental forecast
For a long time, the world’s central banks have been following the path of tightening monetary policy, and now it’s time to stop. The problem is that a soon pause can be misinterpreted by the markets. It hints at the victory over inflation, which may still return. The easing of financial conditions will cost the Bank of Canada dearly as it is about to end the monetary restriction cycle. The BoC must be very careful and not make mistakes in communications. This circumstance affects USDCAD.
Start earlier, end sooner. The Bank of Canada was one of the first to raise the interest rate, bringing it to 4.25%, the highest level in almost 15 years. The slowdown in inflation and the cooling of the economy say it’s time to stop. 12 out of 13 Wall Street Journal experts predict that at the meeting on January 25, the BoC will raise its rate by 25 basis points and then follow with a long pause. Any hint at an end to the cycle will set the stage for a rally in Canadian stocks, falling bond yields, and a weaker currency that will improve financial conditions and increase the risks of a new local high in consumer prices.
Dynamics of Canada’s inflation
Source: Bloomberg.
Tiff Macklem must choose the right words so as not to push the CPI up. The indicator slowed down from its high of 8.1% in June to 6.5%, but inflation expectations remain elevated, and the labor market is strong. Hints at a halt in monetary tightening would heighten the probability of a BoC dovish shift in 2023, leaving the central bank inflexible if consumer prices pick up again.
Alternatively, the head of the Bank of Canada may say that officials are weighing the need for a further increase in borrowing costs. This will be perceived as maintaining a hawkish tone and will provide an opportunity to return to monetary restriction.
A pause in rate hikes looks necessary as a 13% drop in house prices lowers asset values and hurts consumer spending more than in other G7 countries. However, RBC believes that the recession in Canada will be shallow and short, as households and companies have a large cushion. The liquidity at their disposal has increased from CA$40 billion before the pandemic to CA$300 billion.
While the end of the BoC monetary policy tightening cycle is putting pressure on the loonie, the commodities market, on the contrary, is supporting it. Record demand for oil of 101.7 million barrels per day, which the IEA expects to see in 2023 due to the opening of the Chinese economy and problems with supplies from Russia, could send Brent price above $100 per barrel, which will strengthen the currencies of oil exporting countries.
Monthly trading plan for USDCAD, AUDCAD, and EURCAD
If the USDCAD fails to remain above 1.335, it will be relevant to sell the pair down to 1.3265 and 1.3225. Nonetheless, the pair is still quite likely to consolidate. One could also consider buying the AUDCAD and EURCAD with targets at 0.98 and 1.49.
Price chart of USDCAD in real time mode
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