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Currency Forecast
USD/CAD Outlook
Staying within a 500 pip consolidation range following last years lengthy decline, the USD/CAD currency pair remains the object of speculation regarding a move to parity as the underlying spot continues to hover near the 14-year lows seen at the end of last year. Keeping the Canadian dollar a long term favorite in the market has been an array of positive data, bolstering notions that the ninth largest economy in the world is expanding versus global counterparts. Adding fuel to the fire are climbing commodity prices as China continues to advance in the global arena and traders find solace in base metals against worldly price increases. Oil has remained a major positive for the CAD, as prices rise to less than 30 cents away from record heights. This has subsequently added to mounting speculation of increased interest rates as Governor David Dodge and company continue their attempts at remaining preemptive in the fight against inflationary pressures. Already raising rates five times, the market has priced in 4 percent rates and expects the central bank to continue to move beyond that level. Ultimately, this places a lot in favour of loonie bulls as we head into the second half of the year.
Shift in Consumption: Rising Domestic Demand Offsets Export Dip
With the resurgence in global exports over the past year, Canadian economic data has shown great promise when compared to its G7 counterparts. Consumer spending is contributing heavily to the overall growth of the economy as a tight labour market pushes wages and hourly earnings higher, creating a higher standard of living amongst the citisenry . According to the most recent monthly survey published by Statistics Canada, payroll employment created 51,000 jobs in the month of March. Nearly twice the estimated forecast, the figure soars above the four-month moving average and reflects a tighter labour market. In turn, this will ultimately mean more real after tax income for the individuals. In fact, after tax or disposable income is estimated to grow by 5.4 percent in the year and should push consumer spending to an annualised pace of 3.6 percent. Ultimately, this translates into the second consecutive year that stronger consumer spending will carry the economy forward as slower exports dip into growth figures. Subsequently, the boost in full time work has trickled into the housing sector. Having spent a year in the doldrums, the Canadian housing sector has benefited significantly from the impressive growth in Canada, high commodity prices and healthy corporate performance. Housing starts in March alone spiked higher by 252,300 units compared to Februarys 242,500 according to the Canada Mortgage and Housing Corp. Setting a pace not seen in almost 18 years, the robust housing sector is yet another product of the recent decline in the unemployment rate which gives the Bank of Canada good reason to continue to increase interest rates.
Loonie to See Boost as Oil Targets Fresh All-Time Highs
Energy prices have been a major contributor to rising inflationary levels in 2005 and will continue to in 2006 . Although pulling back from the $70.85 high seen just last year, valuations in the commodity have remained lofty amid supply concerns and geopolitical risk in the Middle East. The trend is already continuing as crude prices look set to make yet another all time high. Coincidentally, the recent appreciation has benefited the Canadian economy greatly. As it stands, a sixth of total exports leaving the region are natural gas and crude oil products. This has contributed to a widening surplus, one of only a handful among industrialised countries and positive compared to a widening deficit in one of the worlds largest consumers. According to Statistics Canada, energy contributed heavily to last years surplus as it ballooned to C$66.7 billion with energy products constituting 80 percent of the gap, standing at C$53.6 billion. With higher consumption expected from global trade partners, the trend looks to continue indefinitely, adding to the overall economy. However, a caveat remains in the appreciation of the domestic currency. Higher prices will lead many partners looking for alternative fuels, ultimately lightening demand. Should this occur, the effects may be limited as Growth falls back of strong domestic demand.
More Rate Hikes in Store
Given the hawkish nature of Bank of Canada Governor David Dodge, investors can be assured that rates are likely to rise higher, at least by 25 more basis points, over the second quarter. Although growth remains tepid, rising only slightly above last years as declining exports are likely to eat away at overall growth, there are plenty of fundamental factors that will bolster such a move. Notably, inflationary pressures continue to remain a target as policy officials desire a preemptive stance in curbing future price increases. Although rates of inflation are currently hovering below the target benchmark of 2 percent, recent figures seem to only be reflective of crude oil prices and not rising economic factors. One such example can be shown through the most recent Ivey Purchasing Managers Index which showed that business and government spending in Canada remains formidable as future expectations remain lofty for further expansion. Additionally, scrutiny should be placed on statements issued by the central bank Governor himself. In subsequent statements following the March 7th decision, Governor David Dodge relayed that some modest rate increases may be needed in the future. Considered rather trivial, the statement changed from would to may, which suggested the continuance of an already established hawkish bias.
Conclusion
Given the optimistic economic data, the current bias still anticipates another 25 basis point rate hike at the upcoming meeting. However, several considerations leave open the potential for a pause shortly after the decision,. In recent official comments, keying in on a potential slowdown in overall global growth, Governor Dodge hinted at a potential change in language for subsequent statements following the upcoming decision. Futures expectations have also receded following the most recent spate of statements issued by Bank of Canada Deputy Governor Pierre Duguay. Although echoing earlier central bank sentiment, traders are pricing in the possibility of a near term halt as inflationary pressures are not forecasted to rise immediately. Currently, the implied yield on June bankers acceptance contracts hover unchanged at 4.2 percent.
USD/CAD Technical Outlook
USD/CAD has traded blows from both bulls and bears so far in 2006, rallying as high as 1.1796 on January 19th and plummeting as far down as 1.1297 on March 2nd, making fourteen year lows in the process. A rally from 1.1297 was rejected by the zone formed from the 40 week SMA and 200 day SMA at 1.1752/73 as the pair made a high on April 3rd at 1.1771. Interestingly, the week that ended on 3/24 closed above the dominating resisting trendline that began in January 2002 and had never before been breached. The pair remained outside the trendline for all of two and one half weeks before retreating back towards the middle of the first quarter range concentrated near 1.1500.
Although back below the long term resisting trendline, the fact that the pair did trade through the line, even if for just a week, reveals that the downtrend is not as strong as it once was. Just as telling is the positive divergence with oscillators on the weekly chart, including but not confined to, MACD, RSI, and slow stochastic. The combination of divergence along with the weekly close above the multi-year resisting trendline gives bulls a reason for optimism. The intersection of the trendline comes in at around 1.1575 at present with a break above ultimately exposing the zone between the 4/3 high and 1/19 high at 1.1771/96. Additional gains point towards a test of the 50% fibo of 1.2733-1.1297 at 1.2015, just above the psychological 1.2000 figure. Still, the possibility remains for additional losses on a break below the 1.1297 (3/2) low. The next point of reference comes in at the November 1991 low of 1.1180. Quite interesting to note is the presence of a monthly morning star reversal pattern completed on the close of the March candle, which supports a long term bullish outlook. Any action below 1.1297 would negate bullish implications from the pattern.
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