Canadian Dollar Forecasts for December

USDCAD Long-Term Technical Forecast

I wrote last month that "the corrective nature of the decline from 1.6194 suggests that the USDCAD will eventually exceed 1.6194 (this may take years though). A large correction of the recent rally would serve as wave 2 within the 5 wave impulse that began at .9055." A push through 1.3025 would complete wave (1) and give way to the mentioned wave (2) correction.

USDCAD Fundamental Outlook/Interest Rate Forecast

The US Dollar - Canadian Dollar interest rate differential is forecast to narrow substantially through the coming 12 months of trade, but it is not clear that the USD/CAD will react to interest rate shifts. In fact, the Canadian currency has been far more sensitive to movements in crude oil prices and other commodity costs, and outlook for the Canadian Dollar - US Dollar exchange rate will similarly depend on expectations for commodity prices.

Broader foreign currency markets have proven increasingly indifferent to interest rate differentials. Under normal market conditions, forex speculators will often buy the currencies with higher interest rates and bullish rate outlook-selling those with lower yields and poor rate prospects. Yet we see that the opposite has been true as of late. Extreme financial market duress has forced many speculators to sell high-yielders in order to raise capital. The USD/CAD has subsequently rallied sharply as many traders seek the relative safety of the US Dollar, and continued market turmoil would favor US Dollar strength. Thus we will watch commodities and global equity indices-not interest rates-to guide our forecasts for the Canadian currency.

US Dollar/Canadian Dollar Valuation Forecast

USDCAD Valuation Forecast: Neutral

The Canadian Dollar is effectively at purchasing power parity against the US dollar having rallied sharply since late September. Prices have oscillated around the PPP value at 1.22 for several weeks, with performance and yield considerations pointing in opposite directions. Indeed, the Loonie was the second-best performing currency against USD last month (adding 3.25%) but traders are pricing in substantially more rate cuts ahead for the next 12 months. All told, the picture looks murky for USDCAD with traders likely to find more attractive valuation extremes to exploit in other pairs.

What is Purchasing Power Parity?

One of the oldest and most basic fundamental approaches to determining the "fair" exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the "fair" EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by the Organization for Economic Cooperation and Development (OECD). We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar. Currencies overvalued against the Dollar are denoted in RED, while those that are undervalued are denoted in GREEN.

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