SEB FX Ringside
We expect further downside action in USD/CAD mainly based on favourable valuation and bullish speculative sentiment.
The major risk to our assessment is the possibility of a US border tax introduction by President Trump.
CAD FAIR VALUE MODEL INDICATES USD/CAD AT 1.21 Both our medium-term and short-term fair value models currently brand CAD as undervalued. As can be seen in the chart below our medium-term fair valued model (MTFV, which is a replica of RBA’s fair value model for AUD), indicates that USD/CAD should trade closer to 1.20.
Historically the model has had good predictive power making us confident USD/CAD has good downside potential. We target 1.25 in 3-6 months.
SPECULATORS ARE BULLISH CAD
Another argument for lower USD/CAD is that speculators have turned bullish CAD. For five straight weeks they have increased their net position in CAD moving to a net long position four weeks ago. And despite poor price action they have added to their position in the past two weeks.
This shows that speculators have confidence in the bullish CAD bets which adds to our belief of a future appreciation.
UPCOMING CAD DATA AND EVENTS
This afternoon CPI for January is released which is expected to increase to 1.6% y/y from 1.5% y/y in December. Such a development would of course support CAD as it takes inflation closer to target and puts further pressure on BOC to drop its easing bias.
The Bank of Canada is expected to keep rates on hold at March 1 policy meeting. However, we do expect them to maintain their easing bias at least as long as there is large uncertainty about US politics (mainly US border tax).
Also interesting is Q4 2016 GDP released March 3rd. It is expected to fall to 2.0% from the very strong 3.5% in Q3. Still 2.0% is far better than previous years and would indicate that the Canadian economy is recovering.
RISKS TO THE SCENARIO OF A STRONGER CAD The major risk is the introduction of a US border tax. In that scenario BOC would probably cut the policy rate and possibly hint on QE aiming at weakening the exchange rate by at least 5%. Renegotiation of the NAFTA agreement will not be as bad for the Canadian economy and the February budget has a buffer for negative effects should there be a renegotiation with worse terms. A border tax has some obstacles (e.g. WTO rules stipulating that border adjustments are not permitted for direct taxes) why we believe it would not be implemented in the near future.
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