The Bank of Canada is showing no signs of putting its rate-hiking cycle on hold, despite mounting uncertainty surrounding the conflict in the Middle East and the trade war with the US. However, weakening labor market data is complicating the central bank’s policy outlook. Let’s take a closer look at the situation and develop a trading plan for the USD/CAD pair.
The article covers the following subjects:
Major Takeaways
- Canada’s labor market is disappointing.
- The likelihood of a BoC rate hike is declining.
- The spike in Brent prices is weighing on the Canadian economy.
- Long positions can be considered as long as the price remains above 1.4200.
Weekly Fundamental Forecast for Canadian Dollar
The Bank of Canada raised its overnight rate to 2.5% for the first time in three years, despite mounting economic uncertainty fueled by the conflict in the Middle East and the trade war with the US. The central bank has signaled no intention of abandoning monetary tightening. In practice, everything will depend on incoming economic data. The latest figures triggered the USD/CAD’s strongest intraday performance since September.
CAD/USD Weekly Change
Source: Bloomberg.
In October, Canadian employment fell by 4,700 jobs, pushing the unemployment rate up to 6.7%. For the first time since the pandemic began, employment has declined year to date, highlighting the weakness of the labor market and limiting the Bank of Canada’s room for further monetary tightening. As a result, derivatives markets have scaled back expectations for a December rate hike, lowering its implied probability from 40% to 33%.
Canada’s Employment Rate
Source: Bloomberg.
The USD/CAD pair surged on the divergence between the two economies. US private-sector employment increased by an impressive 165,000 jobs in October, while the unemployment rate fell to 4.1%. The contrasting labor market trends point to diverging economic growth and different monetary policy paths for the Fed and the Bank of Canada. This puts additional pressure on the loonie.
The loonie is also facing headwinds from falling oil prices. As a major energy exporter, Canada is particularly vulnerable to a decline in crude prices. Oil has come under pressure amid growing expectations of a diplomatic resolution to the conflict in the Middle East following the Democrats’ victory in the midterm elections. This adds to the challenges facing the Canadian economy and its currency. At the same time, lower energy prices could help bring inflation down, reducing the need for the BoC to raise interest rates in the near future. This combination of factors weakens the Canadian dollar and creates additional headwinds for USD/CAD bears.
Brent Price and BoC Forecasts
Source: Bloomberg.
Following the Democrats’ victory in the midterm elections, there was some hope that the Canadian dollar could recover. The new Congress was expected to put pressure on the AI industry, potentially encouraging data center operators to relocate from the US to Canada and boosting the Canadian economy. Meanwhile, a weakening of Donald Trump’s political influence could pave the way for lower tariffs. However, these developments will take time, and none is guaranteed. In particular, it is questionable whether Democrats would be willing to slow economic growth by cracking down on the AI industry.
For now, diverging labor market trends, different economic growth trajectories in the US and Canada, and contrasting monetary policy paths for the Fed and the Bank of Canada provide a solid foundation for an uptrend in the USD/CAD. The potential relocation of data centers and an end to the trade war remain uncertain, offering little immediate support to the loonie.
Weekly USDCAD Trading Plan
As a result, it makes sense to maintain long positions in USD/CAD opened on breakouts above 1.4045 and 1.4075, adding to them on pullbacks as long as the pair holds above 1.4200.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of USDCAD in real time mode
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