Loonie may not be weak enough for sufficient rebalancing

In 2015, CAD's 13% fall versus the USD and 8.9% real trade weighted depreciation to-date this year represented a straightforward adjustment to a termsof-trade shock from lower energy prices, with the move reinforced by an active monetary response which saw policy rates slashed 50bp this year.  

The 2016 outlook for CAD is much less straightforward, as energy prices are expected to recover gradually by $15 throughout the year, yet yield differentials will continue to widen in favor of USDCAD as the Fed normalization cycle becomes more fully priced. Thus, forecasting CAD requires a judgement call as to relative sensitivities to higher oil on one hand, and wider spreads under the USD on the other hand.  

One complicating factor is that the substantial trade-weighted depreciation of the CAD may disappoint in its ability to catalyze the rebalancing that the central bank is looking for: CAD is in fact less competitive against key US market competitors MXN, EUR, and JPY, and continues to lose market share even to CNY, the only competitor against which CAD has actually significantly depreciated.  
Meanwhile the expected rebound in oil prices may help reverse the widening of the trade deficit, but will unlikely trigger a rebound in energy sector investment, which represented the bulk of the cyclical contraction caused by the sharp fall in oil.  Put together, the risk is that BoC is disappointed in the lack of a more vigorous recovery, and that the market prices in more policy rate cuts, rather than hikes. (from a currently flat money market curve pricing minimal risk of any policy move in 2016).  

USD/CAD is expected to peak around 1.38 as the Fed hike cycle becomes more fully priced and as energy prices might have one final bout of weakness in the early part of the year. While oil prices may steadily rise as the year progresses, the positive impact to CAD will be very muted, and only expect a retracement back towards 1.34 in the second half of 2016.