Is The Loonie Back In Control After An 18% Rebound Against The USD?

The Canadian Dollar Until Now
In a mere two weeks, the USDCAD has evolved from a clear trick-pony for the greenback to more of an enigma for both technical and fundamental traders. Within this short time, the pair has dropped nearly 300 points in the loonie’s favor after a hitting a 14-month low against the benchmark dollar on February 8.

To put this into perspective, this move represents an 18 percent retracement of the long down trend that began in January of 2002 and bottomed out last summer. The change in the tides seems to be the work of both tangible levels on the charts and a stellar run of data from the Canadian coffers. However, it remains to be seen whether a consistent flow of stronger data will be able to fuel a return to 28-year highs or if this is just a stop on a longer downtrend.
The Big Turn In Fundamentals
For those familiar with the USDCAD, the pair is often regarded as the black sheep of the majors – shrugging off strong dollar bids one day and ignoring the often regarded crude correlation the next. Recently though, the pair has shown an affinity for Canadian-favorable data, suggesting the market was waiting for a reason to bid the currency. Even the most skeptical trader on the sidelines could not ignore the line of indicators that has run across the newswires in the past month. It all started with the November GDP report. Until the most recent growth report was disseminated to the public, economists and monetary officials were looking upon ailing economy. In fact, only two months back, the government reported the biggest monthly contraction in gross domestic output in over three years. Consequently, when the gauge printed a 0.2 percent pick up, it was not hard to rouse loonie bulls. Looking to price action though, it was obvious skepticism anchored the pair as usual. However, as time wore on, indicator after indicator has bested expectations; and cynics are turning into full-fledged optimists.
Among the long list of reports that have touted the strength of the Canadian economy are releases that have been isolated by Bank of Canada – which may signal a change in the central bank’s neutral policy stance may be at hand. In the Canadian economy, there are two sectors that have traded the responsibility for growth on and off over the last decade: exports and consumer demand. Recently, the shipments of Canadian products abroad have suffered as commodity prices have retreated and the currency appreciated. This may be a thing of the past though. The Ivey Purchasing Managers’ Index, often used as a sign of business sector health, rebounded from a yearly low in January. This was backed by a factory shipments report that, with the 1.7 percent jump in December, offered the strongest back-to-back performance since February/March of 2004 and a 9-month high in the physical trade surplus. While export strength may be back in vogue, its contribution to loonie strength may play second fiddle to the performance of domestic demand. Last month’s labor report shocked the market with an 88,900-person addition to the national payroll – more than six times what was expected. In turn, this has supported a jump in consumer spending and financing that has boosted housing construction and retail sales to their highest levels since August 2004 and 1997 respectively. And, lest it be forgotten, the crude oil correlation has sweetened the deal. Since making a quick bottom just above $55 per barrel, the commodity has steadily worked its way back to $60 per barrel. (See the chart below to see the correlation between CADUSD and WTI crude prices)

Technical Outlook[/B]

The chart above shows that recent Canadian dollar strength is consistent with longer term price action, with a 5-year downtrend in the USDCAD showing few signs of slowing. After five months of consecutive gains, the North American currency pair has run into significant resistance at the 50.0 percent retracement of 1.2735 to 1.0930 at approximately 1.1825. All other things remaining equal, this could spell a return to 29-year highs below the 1.0930 mark. Shorter time frames tell us that the pair must clear formidable support levels if this is to occur, however, with a rising trendline and similar Fibonacci marks likely to slow a sharper descent.

A daily chart gives us a much more optimistic view on the future of USDCAD gains, with three compelling sources of support just 60 points below current market prices. A rising six-month trendline has the potential to halt impending losses, with four successful touches underlining the significance of the line. As if this were not enough, the trendline falls at approximately the same levels as the pair’s 100-day moving average, as well as the 38.2 percent retracement of the May, 2006 – February, 2007 uptrend. Bears will likely challenge support within the 1.1520-1.1550 range, but a failure opens the pair to a resumption of previous gains. Otherwise, a break below 1.1520 opens the pair to a re-test of a December swing low at 1.1431.
Considering the technical outlays above, the infusion of impending economic indicators lays out two scenarios for the future of USDCAD. Potentially rallying the loonie optimists behind a continuation to retest 29-year highs, the forthcoming trade and growth data could live up to brightened expectations and rouse a shift in the Bank of Canada’s stiff neutral stance. Next week, the current account balance for the fourth quarter is expected to print a C$6.1 billion surplus compared to C$5.1 billion the month before. More prominent on the calendar though is December’s GDP report. Economists predict the monthly number to accelerate to 0.3 percent. If these numbers impress, then the broader outlook for Canadian economy (and subsequently the currency) would improve. This level of sentiment would certainly be needed to overcome the confluence of support seen at 1.1520/50. On the other hand, even if the data meets the market’s outlook, the resulting fundamental flush may still not impress the typically fickle USDCAD traders. For example, even if the monthly growth report picks up as expected, the annualized quarterly gauge is still looking to slow from a 1.7 percent pace to 1.0 percent. In the end though, it may all boil down to the Bank of Canada. If there is no change in policy makers’ take on the economy, loonie bulls may bow to the unfavorable carry and take profits while they can.