[B][B]Euro / US Dollar Monthly Technical Forecast[/B][/B]
Having nearly reached the 61.8% of the .9055-1.3021 bull wave - divergence with weekly studies warns of a reversal and continuation of the longer term bull that began in November 2007. Last month (August) was the also a Fibonacci 21st month since the November 2007 low at .9055.
The US Dollar/Canadian Dollar remains relatively unaffected by interest rate expectations but we have seen consolidation in both over the past month. The yield differentials between the two neighbors remain relatively unchanged as both saw interest rate expectations decline from a month ago. The Canadian economy is significantly dependant on demand from the U.S. which binds their recovery outlooks and potential timing for policy actions. Indeed, we saw the BoC in lockstep with the Fed during their easing cycle, which should be the case when tightening begins.
However, the USD/CAD exchange rates have maintained its strong correlation to commodity prices in particular oil. Therefore, fluctuations in crude and other raw materials should be watched for indications of volatility. The declining outlook for global growth and fears of tightening lending standards in China, could weigh on commodity prices and in turn the Canadian Dollar. However, long-term demand from the Asian giant is expected to remain robust which could limit downside risks.
[B][B]US Dollar / Canadian Dollar Valuation Forecast[/B][/B]
[B]USDCAD Valuation Forecast: [/B][B]Bullish[/B]
The Canadian Dollar took a beating in August, dropping 2.56% against its US counterpart. Still, USDCAD is substantially undervalued with spot trading 986 pips below its PPP-implied exchange rate. A turn-around in risk appetite is the primary catalyst to watch here, with any return to risk aversion to send USDCAD higher both on overall broad safety demand for the greenback and via the Loonie’s close relationship with the price of oil. Indeed, the pair is now 89.4% inversely correlated with the price of Nymex crude. With stock markets looking increasingly shaky, it appears the greenback may finally close some of the value gap against its northern neighbor in the weeks ahead.
[B]What is Purchasing Power Parity?[/B]
One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.