Canadian Dollar Gains but Remains in Tough Spot, USD/CAD Rejected at Key Support

CANADIAN DOLLAR OUTLOOK:

• Canadian dollar gains on stronger oil prices and a somewhat positive mood on Wall Street, but its outlook remains challenging
• Bets that the Bank of Canada will raise interest rates more aggressively than initially anticipated also supports the Loonie
• USD/CAD falls but fails to breach a key technical support

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The Canadian dollar gained ground against the U.S. dollar on Thursday, bolstered by rising oil prices, after news that the Chinese government is discussing reducing the quarantine period for visitors, a situation that could underpin demand for the commodity. The rise in oil, which is one of Canada’s main exports, could improve the country’s terms of trade, creating a more constructive backdrop for the currency, ceteris paribus.

The somewhat upbeat tone on Wall Street, reflected in an early advance in stocks, also boosted the Loonie, taking USD/CAD to its lowest level in two weeks (1.3651) in the morning trade, albeit only briefly. Typically, when positive sentiment prevails, the U.S. dollar tends to underperform higher beta currencies as traders ramp up their risk exposure.

Recent moves in Canadian bond yields appear to be a tailwind as well. Today, the 2-year note rose to 4.29%, its highest level since October 2007, amid a repricing of the interest rate outlook following the release of last month’s inflation data yesterday. According to the report issued by Statistics Canada, headline CPI came in at 6.9% year-on-year in September, two-tenths above expectations, a sign that the central bank will have to do more to weaken price pressures.

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The inflation upside surprise has increased the likelihood of a 75 basis-point interest rate hike at next week’s Bank of Canada meeting, with futures contracts assigning a 60% probability to this scenario. This anticipated adjustment would bring borrowing costs to 4.0%, a level the Fed’s target rate is seen reaching in November (upper bound).

With the Bank of Canada and the Fed moving at similar speeds in terms of tightening, monetary policy will not be a major bullish catalyst for the Canadian dollar, but could add some support if the risk-on mood persists for a bit longer in financial markets. Conversely, if turbulence returns and recession fears intensify, the U.S. dollar is likely to regain the upper hand on flight-to-safety dynamic.

USD/CAD TECHNICAL ANALYSIS

Looking at the daily chart, USD/CAD is facing support at 1.3650 in case of further weakness. If this floor is taken out decisively, sellers could launch an attack on the psychological 1.3500 level, followed by 1.3425. On the flip side, if dip buyers return and spark a bullish turnaround, initial resistance rests near 1.3840. If this barrier is breached on the topside, a retest of the 2022 highs could be in play.

USD/CAD TECHNICAL CHART

USD/CAD chart prepared using TradingView

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—Written by Diego Colman, Market Strategist for DailyFX