Trade Idea: More room for the loonie to run

There will be traders who are worried that they have missed the recent good run for the loonie. We think that there could be more gains to come, and the Canadian dollar is one currency that could do well vs. the USD in the coming weeks. We think this for four reasons:

1, The US-Mexico-Canada trade deal:

This was finally agreed at the weekend and is better than some had expected it to be. It gets rid of some of the trade angst that had been brewing and allows traders to tick one risk factor from their lists.

2, The Bank of Canada:

Now that Canada has agreed a new trade deal with Trump’s America, it opens the way for the Bank of Canada (BOC) to think about hiking rates and catching up with the Fed. The Bank of Canada has hiked rates twice this year and they are expected to lift rates to 1.75% when they next meet on 24 October. The market is now pricing in a 96% chance of a hike on the 24th, up from 87% chance a week ago. More important for the direction of the loonie, is the future trajectory of rates. Since the new trade deal, expectations for a rate hike to 2% in January have risen above 50% to 55%, up from 45% last week. These odds may increase if the BOC delivers a hawkish signal at its next meeting, which may also boost the loonie.

3, Oil

Canada is one of the world’s major oil producers, and the loonie is considered a commodity currency. The WTI oil price has risen above $75 per barrel in the last 24 hours, which is the highest level since 2014, and momentum remains strong, so there could be room for further oil price appreciation. Thus, the loonie may continue to benefit from the upside in the oil price.

4, Technical analysis

The technical picture is also supportive for the CAD. As you can see in the chart below, USD/CAD has retraced 50% of its February to June rally. This is a critical zone from a technical perspective. If you follow Fibonacci technical analysis, then last week’s decisive drop below 1.2960 – the 38.2% retracement and a key Fib level – opens the way to further losses below 1.2690 – the 61.8% Fib retracement. Currently USD/CAD is trading at 1.2822, thus there is the potential for more than 120 pips of further downside, based on Fibonacci analysis.

Chart 1: USD/CAD daily chart

Source: Capital Index and Bloomberg