USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

[B]US Dollar / Canadian Dollar Monthly Technical Forecast[/B]

In the process of retracing the major 2008-2009 low-highs with the market now approaching critical Fibonacci support by 1.0600, which represents the 61.8% retracement off of the move. Ultimately any additional setbacks are seen limited with our outlook remaining quite constructive despite the latest sharp retreat. A medium to longer-term higher low is now sought out above parity and by current levels just over 1.0500 ahead of the next major upside extension back into the 1.2000’s over the coming weeks/months. As such, we continue to recommend looking for opportunities to buy at current levels.

[B]US Dollar / Canadian Dollar Interest Rate Forecast[/B]

The US Dollar/Canadian Dollar exchange rate has shown very little correlation to interest rate forecasts, and we have little reason to believe that said dynamic will change through the foreseeable future. Overnight index swaps currently predict that Bank of Canada and US Federal Reserve interest rates will be roughly equal in a year’s time. Barring any significant and/or unexpected shift, said predictions leave little interest rate bias for the USDCAD.

The exchange rate remains closely linked to global commodity prices, and the USDCAD-Crude Oil correlation trades near record-highs. It will subsequently be very important to monitor trends in raw materials prices, and their recent uptrend bodes well for the Canadian Dollar.

[B]US Dollar / Canadian Dollar Valuation Forecast[/B]

The Canadian Dollar has outperformed the spectrum of major currencies in July as risky assets continued to push higher, with the currency able to find a catalyst beyond overall US Dollar weakness in the rebounding price of oil. Indeed, USDCAD now shows a whopping -89.9% inverted correlation with Nymex crude. As with most of the majors, however, the operative question going forward concerns the longevity of the current bout of risk-taking. An increasing number of observers are suggesting that oil is becoming decoupled from underlying fundamentals of demand, with recent buying driven by the desire for a tangible asset hedge against future inflation born of the aggressive monetary easing that has been put in place to check the onset of what looked like the next Great Depression. However, the IMF has forecast that consumer price growth will average less that 3% for the world at large and a mere 0.5% for advanced economies through 2010, figures that seems hardly indicative of a catastrophic spike in inflationary pressure. Indeed, infamous New York University professor Nouriel Roubini that has earned the nickname “Dr. Doom” for predicting the 2008 credit crisis and recession recently said that deflation, not inflation, is the biggest threat to a sustained rebound and chalked recent oil gains as being driven primarily by “speculation”. If this is indeed the case, the Canadian Dollar could tumble as quickly as it rallied when the underlying fundamentals of the global economy replace current euphoria as the catalyst for price action, offering USDCAD bulls a lucrative value gap to be exploited.

[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.