Canadian Dollar Forecast: Weakening US Labor Market to Weigh on USD/CAD

USD/CAD WEEKLY FORECAST: MILDLY BEARISH

• USD/CAD has corrected lower and fallen more than 400 pips in the last two weeks
• Weakness in the U.S. labor market and its implications for the Federal Reserve’s monetary policy support the case for further U.S. dollar weakness in the near term. The technical outlook is also somewhat negative
• However, the bearish USD/CAD’s narrative could change if market sentiment sours on worsening economic data or Bank of Canada adopts an ultra-dovish stance

The U.S. labor market cooled sharply in August, hurt by weakness in the leisure and hospitality sector amid another major coronavirus outbreak. According to the nonfarm payrolls (NFP) report, the economy created only 235,000 jobs, well below the consensus of 733,000 new hires and the lowest print since January, when COVID-19 vaccinations were just beginning.

The hiring downshift will likely lead to Fed to be more patient before reducing asset purchases and almost certainly prevent a September taper announcement. An accommodative-for-longer stance by the central bank could potentially slow the recovery in US Treasury yields and weigh on the broad US dollar index. Theoretically, this could support the Canadian dollar (CAD) and push the USD/CAD exchange rate lower in the coming days, accelerating the 400+ pips correction that began two weeks ago.

While the stars seem to be aligned for more USD depreciation, it is critical to closely monitor market sentiment, as concerns about air pockets in the US and Chinese economy can trigger a flight-to-safety reaction at any time. Needless to say, a risk-off episode can spark higher volatility, hit growth-linked commodities (e.g., oil) and weigh on high-beta currencies such as the Canadian dollar.

Another potential headwind for CAD to watch in the week ahead is Bank of Canada’s rate decision. Although no fireworks are expected, the institution could adopt a more cautious tone on the economic recovery in light of the second quarter unexpected GDP contraction (Q2 GDP shrank 1.1% annualized vs expectations of a 2.5% increase) .

With downside risks increasing for the current quarter, we could see some dovish tweaks in the policy statement and perhaps an acknowledgement that the output gap will take longer to close. The bank, however, will refrain from altering the outlook significantly in an effort to stay above the fray ahead of the September 20 snap election. In this sense, the October meeting, which comes with new macroeconomic forecasts, can be more relevant and market moving.

USD/CAD TECHNICAL OUTLOOK

USD/CAD has sold off in recent days, falling from a eight month high of 1.2949 to 1.2518, a drop of more than 400 pips in less than two weeks. This leg lower has pushed the pair below a short-term rising trendline and the 200-day moving average, a bearish signal for price action. If sellers retain control of the market in the coming week, we have a major technical support in the 1.2480 area, which corresponds to the 50% Fibonacci retracement of the 2021 rally. If this floor is taken out decisively, we could see a move towards 1.2422, followed by 1.2369.

Alternatively, if a rebound takes place unexpectedly, the first cluster resistance appears in the 1.2650 area. If bulls manage to push prices above this barrier, buying momentum could accelerate and drive the exchange rate towards the July high in the 1.2807 vicinity.

USD/CAD TECHNICAL CHART

Source: TradingView

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—Written by Diego Colman, DailyFX Market Strategist