CAD outlook

The Canadian dollar (CAD) has settled into a comfortable trading range over the past month, awaiting developments on the domestic fundamental front or from external influences, such as the USD and energy prices.

The oil price shock has seen the Canadian economy decouple from the US economic locomotive, something that the H1 contraction in domestic output underscored. This is unusual and Q3 trends suggest that the economy is not regaining momentum all that quickly. 

"Broadly, these factors are still aligning negatively for the CAD. The outlook for the currency is bearish as a result. Assuming the Fed reaches lift-off before year-end, a combination of higher US rates (and wider yield spreads versus the CAD) and low oil prices will lift USD/CAD to just below 1.40 in H2 2016", says Scotia Bank.

The growth is likely to remain relatively sluggish in the coming year. The Bank of Canada's (BoC) aim of re-orienting the economy from domestic-driven growth to (more sustainable) drivers, such as trade and business investment, has only been partially successful. 

Trade has improved a little in recent months but business investment looks flat and may struggle to improve against the soft energy sector backdrop. Under these circumstances, policymakers will likely prefer to see the CAD stay relatively soft. 

The BoC has frequently stressed the "shock-absorbing" role of a flexible exchange rate in helping the Canadian economy cope with exogenous shocks. As such, it is suspected that the BoC will take a dim view of CAD strength that is not rooted in improving domestic fundamentals.

There is little doubt that the mid-year rally in USD/CAD has lost some momentum. Consolidation is the order of the day at the moment but we think this is the kind of sideways range trade that typically foreshadows another trend extension (up, in this case). 

"The seasonal patterns are likely to help out, the USD usually does well against the CAD late in Q4 and early in H1 of the following year. From here, gains above 1.3250 will be positive for the USD and we expect solid USD support on weakness to the 1.28 area", added Scotia Bank.