Canadian dollar likely to get smashed this week. Could the USD/CAD break 1.34?
When compared to a very strong USD, the CAD ended the week off its low but remained weak. Along with its G10 commodities FX rivals, the CAD has underperformed as global stocks, led by US markets, have continued to lose value. The VIX remains shy of the 30-plus point level which typically indicates higher levels of market concern, however volatility has increased but remains constrained close to the peaks that have persisted over the last month. The CAD's relationship to the S&P 500 is getting stronger, and short-term CAD movement is still heavily influenced by equity markets. The correlation between the CAD and the S&P 500 rose a little above 80% last week and stands as one of the highest among the major currencies.
Sluggish growth forecasts
I the shornt term, FX is likely to keep reflecting patterns in the world stock market. Stocks serve as a gauge of global economic health, and investors are undoubtedly alarmed by the prospect of more tightening of monetary policy by central banks around the world as they continue to combat persistent inflationary pressures. The tracking of GDP in both the US and Canada indicates sluggish growth momentum, and Fedex, the world's largest shipping company, has warned of decreased activity in Asia and difficulties in Europe, suggesting that trade may be drastically slowing down. Fair value models suggests no mitigating factors for the CAD and ongoing upside risks for the USD in the short run. Beyond the weakening in the equity markets, we note that spreads have all shifted in favor of the USD as commodities prices weakened once more last week. These variables point to little potential for a short-term CAD comeback and ongoing upside risk for the USD/CAD towards 1.3350.
FOMC and the week ahead
Although there is a good deal of data to be released this week, the FOMC decision is basically he only calendar entry of any real significance for the FX markets. Markets are now taking into account the possibility of a big rate hike due to evidence of "sticky" inflation in the US which was evidenced by the higher-than-expected core CPI data. Markets have priced in a 3/4-point tightening as well as a 20% probability that the Fed goes a full point. Currently, around two-thirds of the economists in the Bloomberg survey anticipate a 75bps increase, with about a third anticipating a 50bps increase. For a 100bps move, there are just two submissions. The Fed rarely disappoints market pricing so a 75bps hike remains most likely—which may provide a modest relief rally for risk assets. Messaging may remain hawkish, possibly teeing up another 75bps in Nov, would likely weigh on risk appetite. A 100bps increase would unmistakably be bad for risk. In Canada, the major release is the CPI data for August. The BoC will continue to tighten monetary policy in November as long as core inflation remains high (markets are presently pricing in an increase of 50 basis points).
This week’s USD/CAD trading range
We look for USD dips to remain well supported on weakness to the low/mid-1.32s and spot resistance at 1.3420.
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