USDCAD Monthly Technical Forecast
The multi-year count treats the decline from 1.6194 as a correction (zigzag), indicating that the USDCAD should exceed that level eventually. In the month ahead, the USDCAD most likely rallies through 1.3025 in order to complete 5 waves from .9055. 1.40 is a bullish target going forward. Staying above 1.2020 keeps this forecast on track.
USDCAD Fundamental Outlook/Interest Rate Forecast
Although the Bank of Canada has a scheduled interest rate decision in April, it is highly unlikely that they will continue easing as their benchmark rate already stands at 0.50%. Therefore, the 45 bps it cuts that are expected over the next twelve months by overnight index swaps is more of a measure of the downside risks to the economy. Despite the dovish expectations, we have seen the spread between the Fed Funds Rate and the BoC benchmark narrow to 78 from 81.
However, price action for the pair may be more dependent on commodity prices which have started to find support as the outlook for the global economy improves. This could be a bearish factor for the USD/CAD and may offset the bullish bias that the interest rate spreads are generating.
US Dollar – Canadian Dollar Valuation Forecast
USDCAD has overshot is PPP level and now stands in overvalued territory. While this is generally bearish, it seems likely that near-term catalysts will fuel the bullish USDCAD run for some time yet before a correction lower can materialize. Most notably, Canadian authorities proved to be over-optimistic about the country’s ability to withstand the global downturn. As it stands, overnight index swaps show the market expects the deepest rate cuts from the Bank of Canada in the coming 12 months, putting the Loonie at a clear disadvantage. Further, BOC Governor Carney’s recent overtures about quantitative easing put him even further behind the curve: most major currencies (notably USD, GBP, CHF and JPY) have already weathered the brunt of the market’s gut reaction to such measures. This process still lies ahead of the Canadian unit, hinting that the current disparity in valuation is not ready to be exploited to the short side as of yet.
What is Purchasing Power Parity?
One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by the Organization for Economic Cooperation and Development (OECD). We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar. Currencies pairs that are undervalued against their PPP exchange rate have the size of the value gap denoted in RED, while those that are overvalued are denoted in GREEN.
