USD/CAD to new highs by 2016

USD/CAD has extended sharply higher through July with the help of a 25bps rate cut from the BoC. The monetary policy divergence theme has been at the core of our view of higher USD/CAD through 2015, but our call for a peak of 1.31 in Q3 did not incorporate last month's BoC cut. 

"RBC now looks for the BoC to remain on hold until an eventual hike in Q3 2016, which is premised on a gradual rebound in Canadian activity that should begin to show more clearly in the second half of this year. That is essentially just a modest extension or delay to the outlook that was held in recent months, so the general profile looked for in USD/CAD remains the same, a peak in H2 of 2015 before a gradual pullback through 2016", says RBC capital markets. 

Also, the difference is that the recent BoC rate cut effectively notches up that profile by taking 25bps out of the forward curve. A peak of 1.34 is expected in Q3/Q4, and the main drivers of the continued near-term rally should be:

Monetary policy divergence, The BoC should maintain a cautious tone in the coming months, while the Fed appears close to starting its hiking cycle. The US side is not fully priced for that and should drive stronger USD.

Soft Canadian activity, Q2 growth is shaping up to be another soft quarter, and what matters now is whether we begin to see the rebound in Q3/Q4-that the BoC has said they expect. That will be the case, but those releases don't come out until late 2015/early 2016.

Oil is back at the lows and adds downside risk to CA activity outlook without a considerable rebound by early next year.

Any significant shift is not anticipated in the larger energy sector outlook unless prices rise above the breakeven threshold for new oil sands projects.