Canadian Dollar May Yield to Fundamentals as Labor Market Falters

[B][B]Canadian Dollar May Yield to Fundamentals as Labor Market Falters[/B][/B]

[B]Fundamental Forecast for Canadian Dollar: [/B][B]Neutral[/B]

The Canadian dollar rose to a fresh yearly high against the greenback this week, with the USD/CAD falling to a 10-month low of 1.0749, and the pair may continue to retrace the advance from the previous year as market participants speculate the Bank of Canada to tighten policy over the next 12 months. Credit Suisse overnight index swaps shows investors anticipate the central bank to hike borrowing costs by nearly 100bp next year as growth prospects improve, and the rise in the interest rate outlook may continue to support the rally in the loonie as policymakers anticipate an economic recovery later this year.

At the same time, a report by Statistics Canada released earlier this week showed prices for raw materials jumped 6.2% in June, driven by higher energy costs, and the rise in business expenditures may lead firms to take additional steps to lower their cost-structure as they continue to face fading demands from home and abroad. As a result, the economic docket for the following week may reinforce a weakening outlook for future growth as economists forecast the annual rate of unemployment to rise to 8.8% from 8.6% in June, which would be the highest reading since January 1998, the downturn in global trade may lead firms to scale back on production and employment throughout the remainder of the year as trade conditions deteriorate. Meanwhile, as BoC Governor Mark Carey continues to see a risk of a slower recovery due to the recent appreciation in the Canadian dollar and retains the flexibility to utilize policy tools beyond the interest rate, speculation for further easing could instill a bearish outlook for the USD/CAD going forward, and the pair may continue to hold a broad range over the following month as investors weigh the outlook for future policy. - DS