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USD/CAD Wavers at Support, Canadian Dollar Outlook Hinges on Market Sentiment


  • The Canadian dollar has weakened sharply against the U.S. dollar in recent weeks, despite strong oil prices sitting at multi-year highs
  • Although fundamentals favor Canadian dollar strength, sentiment will continue to dictate the near-term direction of high-beta currencies
  • Market mood could begin to improve soon once China rolls back lockdowns and other restrictive mobility measures

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Oil became one of Canada’s main exports after 2008. As a result, the country has seen its terms of trade improve and its currency shore up during periods of rising commodity prices. Now, however, something seems to be amiss. Over the last few months, as crude soared to multi-year highs, the Canadian dollar has weakened counterintuitively against the US dollar, with USD/CAD up more than 4% from its April lows.

Recent price action raises two important questions: what is driving the greenback’s outperformance, and will the trend persist? Examining possible catalysts, it cannot just be monetary policy divergence or yield differentials, because the Bank of Canada has moved almost in lockstep with the Fed, aggressively front-loading interest rate hikes to control inflation. Second, the U.S. dollar’s strength cannot be driven solely by U.S. exceptionalism either, because the Canadian economy is in a much better position, with analysts forecasting its gross domestic product to grow by 4.5% this year and 3% in 2023, almost double what is expected for the United States.

If not fundamentals, what’s been buoying USD/CAD? Market sentiment is the likely culprit. The recent risk-averse tone and extreme levels of volatility on account of stagflation anxiety have generated a strong bid for safe haven assets, leading traders to dump high-beta currencies. The following chart, which overlays S&P 500 futures and USD/CAD (inverted scale for better visualization), seems to support the sentiment argument. In it, we see an almost perfect negative correlation between the two assets since the start of the war in Ukraine, with every stock sell-off coinciding with a spike in USD/CAD.


USDCAD vs S&P 500 futures

Source: TradingView

Given that negative sentiment has been the main bearish catalyst for the Canadian dollar, it is reasonable to argue that the trend could quickly reverse once the situation improves and global equities stop the bleeding, allowing the currency to align with its solid fundamentals. With China suggesting that the government could begin dismantling the Shanghai lockdowns in the coming days, the extreme state of pessimism could begin to ease, paving the way for risk assets to stabilize. That said, the “loonie” is well-placed to command strength against the U.S. dollar should the mood veer from fear to cheer. This means that a large pullback in USD/CAD could be just around the corner.

In terms of technical analysis, after being repelled by Fibonacci resistance at 1.3025, USD/CAD has fallen towards a key support in the 1.2900 area. If the bears manage to breach this floor on the downside, selling activity could accelerate, paving the way for a move towards 1.2725. On further weakness, the focus shifts down to the 2022 lows, spanning from 1.2460 to 1,2400. On the flip side, if buying momentum resumes, initial resistance appears at 1.3025. If this ceiling is broken, bulls could launch an attack on 1.3180.



USD/CAD chart prepared using TradingView


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—Written by Diego Colman, Market Strategist for DailyFX

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