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Canadian Dollar Forecast: Do Breakouts Have Legitimacy? – Key Levels for CAD/JPY & USD/CAD

Canadian Dollar Forecast Overview:

  • If the Canadian Dollar is going to gain ground, it appears USD/CAD rates are more likely to deliver on that potential than CAD/JPY rates at present time.
  • May Canada GDP figures are due out on Friday, July 31, and expected to show that the Canadian economy returned to growth faster than either Japan or the United States.
  • According to the IG Client Sentiment Index, USD/CAD rates have a bearish trading bias at the start of the new week.
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Canadian Dollar Clawing for More Gains

Even as energy markets continue to slowly but surely drift higher, yet the occasional bout of volatility on virus- or trade-related headlines circulating around the United States has held back the Canadian Dollar has in recent days.

Yet with a risk environment that remains robust thanks to ongoing stimulus efforts by central banks and governments around the developed world, the Canadian Dollar remains on relatively sturdy ground: the coronavirus pandemic didn’t hit the Canadian economy as hard as it did to its largest trading partner, the United States.

While the forex economic calendar is rather thin over the coming week, the last day of the month will offer up the May Canada GDP report, due to show that the economy gained +3.5% m/m after plunging by -11.6% in April. Evidence that the Canadian economy returned to growth faster than either Japan or the United States, for example, should help clarify recent breakout attempts in both CAD/JPY and USD/CAD rates.

BOC Interest Rate Expectations Not Holding Back CAD

The ongoing improvement in Canadian economic data is a trend that the Bank of Canada will continue to monitor with caution, taking solace in the fact that the economy has weathered the storm but it is not in the clear yet. With no BOC meeting scheduled until September, it’s of little surprise that market participants are watching the improvement in Canadian economic data as evidence that the BOC will stand pat for the foreseeable future.

Bank of Canada Interest Rate Expectations (July 27, 2020) (Table 1)

Canadian Dollar Forecast: Do Breakouts Have Legitimacy? - Key Levels for CAD/JPY & USD/CAD

Bank of Canada interest rate expectations have barely moved in several weeks. At the end of April, there was a 55% chance of a 25-bps interest rate cut in December 2020, according to Canada overnight index swaps. Now, there is a 2% chance of a 25-bps rate hike through December 2020.

Even if economic conditions continue to improve, that Canada’s largest trading partner, the United States, of which 20% of Canadian GDP is derived, continues to suffer from the coronavirus pandemic will leave the BOC more cautious about normalizing interest rates than they may have been otherwise if the United States managed its COVID-19 outbreak more effectively.

USD/CAD Rate Technical Analysis: Daily Chart (July 2019 to July 2020) (Chart 1)

Canadian Dollar Forecast: Do Breakouts Have Legitimacy? - Key Levels for CAD/JPY & USD/CAD

While the downtrend from the March and May swing highs remains intact, focus has shifted to two potential triangles’ support: from the June and July swing lows, which broke on July 21; and from the January and June swing lows, which now been broken. This is occurring the break in the rising trendline from the September 2012 and September 2016 lows; several key support levels are under duress.

Bearish momentum has continued to accelerate. USD/CAD rates are below their daily 5, 8-, 13-, and 21-EMA envelope, which is still in bearish sequential order. Daily MACD is trending lower below its signal line, while Slow Stochastics are still ins oversold territory. Short-term momentum indicators suggest that more losses may be on the immediate horizon for USD/CAD rates.

USD/CAD Rate Technical Analysis: Weekly Chart (December 2016 to July 2020) (Chart 2)

Canadian Dollar Forecast: Do Breakouts Have Legitimacy? - Key Levels for CAD/JPY & USD/CAD

There may no longer be a longer-term upside bias in USD/CAD rates as this narrative is under threat given the potential for the pair to break the rising uptrend from the September 2012 and September 2016 lows. In the event that this trendline does give way over the coming sessions, the longer-term view would shift from a bullish symmetrical triangle to a bearish double top.

IG Client Sentiment Index: USD/CAD Rate Forecast (July 27, 2020) (Chart 3)

Canadian Dollar Forecast: Do Breakouts Have Legitimacy? - Key Levels for CAD/JPY & USD/CAD

USD/CAD: Retail trader data shows 63.73% of traders are net-long with the ratio of traders long to short at 1.76 to 1. The number of traders net-long is 5.63% higher than yesterday and 52.19% higher from last week, while the number of traders net-short is 17.56% higher than yesterday and 22.85% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USD/CAD prices may continue to fall.

Positioning is less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed USD/CAD trading bias.

CAD/JPY Rate Technical Analysis: Daily Chart (July 2019 to July 2020) (Chart 4)

Canadian Dollar Forecast: Do Breakouts Have Legitimacy? - Key Levels for CAD/JPY & USD/CAD

CAD/JPY rates failed in their bullish breakout attempt last week, proving to return to the sideways range between 78.03 and 79.65. Perhaps this was (and remains) an invalid interpretation of near-term price action; it also holds that a series of higher highs and higher lows has formed after the late-June low. To this end, retaking the 2019 low and symmetrical triangle swing highs near 78.50, and maintaining the move above 78.50, has given credence to the idea that the bottom is in.

It’s important, for now, that CAD/JPY rates have sustained their climb back above the rising trendline from the 2009 and 2016 lows, helping solidify the perspective that the symmetrical triangle, having formed between early-March and mid-May, was, indeed, a significant bottoming effort.

For now, CAD/JPY rates are back in the ranges for which they’ve now trade for the past three weeks, between 78.03 and 79.65. CAD/JPY rates are below their daily 5-, 8-, 13-, and 21-EMA envelope, which is in bullish sequential order. Daily MACD is turning lower while hovering above the signal line, while Slow Stochastics have quickly exited overbought territory. If the Canadian Dollar is going to extend its gains versus one of the global funding currencies, it appears that USD/CAD is better suited for the task than CAD/JPY.

CAD/JPY Rate Technical Analysis: Weekly Chart (June 2007 to July 2020) (Chart 5)

Canadian Dollar Forecast: Do Breakouts Have Legitimacy? - Key Levels for CAD/JPY & USD/CAD

Bigger picture for CAD/JPY rates: while there is much ground to be made up to get back to the 2020 highs established in late-February, breaking out above 78.50 has seen CAD/JPY rates rise above the descending trendline from the October 2018 and July 2019 lows, offering another piece of evidence that a near-term low – if not the long-term bottom – may have been established.

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— Written by Christopher Vecchio, CFA, Senior Currency Strategist