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USDCAD bulls beware as oil takes over

by Ashraf Laidi

Be careful when shorting the Canadian dollar. The Bank of Canada may have shocked the world with its first rate cut in six years due to the damage on the economy tumbling oil prices, but the loonie has shown its share of sharp rebounds ever since. USDCAD has lost more than half of the 6% advance accumulated since January 21st rate cut. Oil’s rebound played a major role. But USD optimism is also running too far.

Among the fundamental dynamics noted in favour of temporary CAD gains are expectations that any perceived gains from the US economy will favour the CAD in the medium term. Since the bulk of the loonie’s depreciation vs. the USD began back in November weakening in November, the BoC will inevitably start taking this variable into consideration before assessing the need for additional easing.

Oil spike

Yet, the more considerable catalyst to stabilizing CAD will likely emerge from oil prices as it has proven to be the case over the last 2 weeks. The latest data on oil rig count from Baker Hughes showed a fresh three-year low of 1,140– a 30% decline from the October peak. The 3-week rally in US crude oil prices proved to be tremendous help for the loonie as WTI nears its 55-DMA of $54.37, while brent crude has already broken its 55-DMA, hitting a new six-week high at $61.30. Assuming a continuation of the present momentum, Brent could reach $62.90 by next week and WTI may surpass $55.00.

Fed considerations

USD bulls may continue to retreat ahead of next week’s release of the FOMC minutes from the January meeting and and Yellen’s Congressional testimony due later this month, both expected to pare down expectations of a June rate hike-despite the release of last week’s Friday’s stellar US jobs report. We cannot emphasize enough the importance of the Fed’s willingness to pause on rates before inflation begins to normalize.

Overlaying past with present

Chartists ought to view the overlay between daily USDCAD chart Sep 2013-March 2014 and the daily USDCAD from today. The rally from September 2013 peaked out in Jan 30th 2014 before losing about 3 cents in over 2 weeks. The decline was a surprise to many who expected the USDCAD advance of January 2014 would be “the one”. The formation is similar to the USDCAD’s rally from September 2014 into the peak of January 30th of this year.

The BoC may continue to talk down the loonie as Deputy governor Wilkins has done earlier this week. But a historic overlay of the chart provided a reminder of the excessive CAD bearishness prevailing this time last year, which turned out to be excessively early. A retest of 1.2350 isn’t ruled out.

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