The CAD's price action last week showed just how much risk sentiment is once again dominating currency markets. US stocks fell precipitously as a result of the hawkish reading of the Fed Chairman's Jackson Hole remarks, and FX correlations subsequently increased. The CAD recovered toward the end of the week as markets rose in response to US job data that revealed an unexpected increase in the unemployment rate. Domestically, Canada released somewhat weaker-than-anticipated Q2 GDP data last week, and during the past few days, speculation has increased that rates will be aggressively raised this week.
CAD driven by risk environment; not fundamentals
Compared to spreads and commodities as drivers for the CAD, the current environment is highly associated with the risk environment. The current backdrop may indicate further softness for the CAD, or at the very least a period of relatively weak trading, against the USD notwithstanding Friday's stock market recovery. The two months of August and September together represent the worst two-month stretch for US equities over the course of the year, according to seasonal studies. Market breadth indicators for NYSE-listed stocks are also deteriorating again following the market recovery in June and July, which adds to the gloomy outlook for equities. Seasonal patterns indicate that risk appetite normally increases dramatically in Q4; this leaves a four-to-six-week window where the possibility of weak stocks and increased volatility can loom over the CAD. The CAD has benefited a little from an improvement in the risk environment, but fair value models still show some underlying CAD fragility, and the unclear risk outlook may force CAD trading to be defensive in the short to medium term.
The week ahead
Despite the fact that this week is short and not very remarkable on the calendar, there are a few important releases to pay attention to. The Bank of Canada's policy meeting on Wednesday is undoubtedly the most important event in Canada; we anticipate a 75-bps increase in the Overnight Target Rate, which is already fairly priced in by the markets. Since this is a statement-only event, we may not learn too much about the policy outlook, but the Bank seems likely to continue with its strong messaging on controlling inflation, which raises the possibility of additional, cumulative 75bps rate hikes, at least over the course of the upcoming few months. The rate decision overshadows the Trade and Ivey PMI data on Wednesday, and if BoC rhetoric is kept aggressive, the jobs data on Friday may not have much of an impact on the CAD. ISM Services statistics for August, July Trade, and weekly claims are among the US data releases. Before the FOMC decision on September 21st, the Fed publishes the Beige Book. On Thursday, Chairman Powell will present at a conference on monetary policy.
This week’s USD/CAD trading range
The short-term technical picture suggests that the USD/CAD may peak around 1.32 with support located at around 1.2975.
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