USD/CAD Trades in Defined Range as US Dollar Tracks Risk Sentiment

Canadian Dollar Talking Points

USD/CAD consolidates after breaking out of the opening range for January, but swings in risk appetite may sway the exchange rate ahead of the Bank of Canada’s (BoC) first meeting for 2021 as the US Dollar still reflects an inverse relationship with investor confidence.

USD/CAD Trades in Defined Range as US Dollar Tracks Risk Sentiment

USD/CAD fails to extend the series of lower highs and lows from the previous week as it quickly pulls back from a fresh monthly high (1.2835), and the exchange rate may face range bound conditions over the coming days as the BoC appears to be track to retain the current policy at the next interest rate decision on January 20.

Image of BoC Business Outlook Survey

Source: BoC

The update to the BoC Business Outlook Survey may encourage Governor Tiff Macklem and Co. to endorse a wait-and-see approach for monetary policy as “most firms expect sales to increase in the next 12 months,” and it remains to be seen if the central bank will adjust the forward guidance in 2021 as the “results point to increased positive pressures on input costs, largely related to rising freight costs.

Nevertheless, it seems as though the BoC is in no rush to scale back its emergency measures as Business Outlook Survey goes onto say that “consumer price inflation is expected to remain somewhat below 2 percent over the next two years,” and key market themes may continue to influence the exchange rate in 2021 as Governor Macklem and Co. acknowledge that “a broad-based decline in the US exchange rate has contributed to a further appreciation of the Canadian dollar.

In turn, swings in risk appetite may continue to sway USD/CAD as the US Dollar still reflects an inverse relationship with investor confidence, and it looks as though the tilt in retail sentiment will also persist as traders have been net-long the pair since May 2020.

Image of IG Client Sentiment for USD/CAD rate

The IG Client Sentiment report shows 68.14% of traders are still net-long USD/CAD, with the ratio of traders long to short standing at 2.14 to 1. The number of traders net-long is 2.72% higher than yesterday and 6.19% higher from last week, while the number of traders net-short is 3.22% higher than yesterday and 1.67% lower from last week.

The recent rise in net-short position has helped to alleviate the crowding behavior as 68.91% of traders were net-long USD/CAD at the end of last week, but the rise in net-long interest suggests the tilt in retail sentiment is likely to persist even though the exchange rate quickly pulls back from a fresh monthly high (1.2835).

With that said, key market themes may continue to influence USD/CAD as major central banks rely on their non-standard tools to achieve their policy targets, but the exchange rate may face range bound conditions ahead of the next BoC rate decision as it fails to extend the series of higher highs and lows from the previous week.

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USD/CAD Rate Daily Chart

Image of USD/CAD rate daily chart

Source: Trading View

  • Keep in mind, USD/CAD cleared the January low (1.2957) following the US election, with the exchange rate trading to fresh yearly lows in November and December as the Relative Strength Index (RSI) established a downward trend during the same period.
  • USD/CAD started off 2021 by taking out last year’s low (1.2688) even though the RSI has broke out of the bearish formation, with lack of momentum to hold above the 1.2770 (38.2% expansion) region pushing the exchange rate towards the 1.2620 (50% retracement) area.
  • However, USD/CAD has broken out of the opening range for January following the failed attempt to test the 1.2620 (50% retracement) area, with the rebound from the monthly low (1.2630) pushing the exchange rate towards the 1.2830 (38.2% retracement) region.
  • Need a close above the 1.2830 (38.2% retracement) to bring the Fibonacci overlap around 1.2950 (78.6% expansion) to 1.2980 (61.8% retracement) on the radar, with the next area of interest coming in around 1.3030 (50% expansion) to 1.3040 (61.8% expansion).
  • At the same time, failure to close above 1.2830 (38.2% retracement) may generate range bound conditions in USD/CAD, with lack of momentum to hold above the 1.2770 (38.2% expansion) region raising the scope for another test of the 1.2620 (50% retracement) area.

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— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong




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