The US Dollar to Canadian Dollar (USD/CAD) exchange rate has strengthened steadily over the past two weeks and is trading near 1.3900 after climbing from levels below 1.38 at the end of May.
Scotiabank notes that a run of disappointing Canadian economic data has contrasted sharply with stronger US releases, helping to widen interest-rate differentials in favour of the US Dollar.
The bank believes these widening yield spreads have been a key factor behind USD/CAD’s recent gains and the Canadian Dollar’s underperformance.
Although Scotiabank estimates that USD/CAD is trading above its short-term equilibrium value of 1.3689, it cautions that valuation alone may not be enough to trigger a sustained Canadian Dollar recovery.
The bank continues to argue that weak domestic fundamentals and lingering uncertainty surrounding trade relations mean the Canadian Dollar is heavily influenced by developments outside Canada.
As a result, external factors such as US economic performance, Federal Reserve expectations and trade developments are likely to remain the dominant drivers of USD/CAD in the near term.
From a technical perspective, Scotiabank notes that the Canadian Dollar’s latest losses have reversed bearish signals that had started to emerge on the charts last week.
While the bank sees scope for some short-term relief for the Canadian Dollar, the move above the mid-1.38 area leaves USD/CAD vulnerable to a retest of the late-March high at 1.3967.
Scotiabank also points out that rallies above 1.39 have struggled to hold this year, with the Canadian Dollar often staging a relatively quick recovery once the pair reaches these levels.
For now, however, the combination of stronger US fundamentals and weaker Canadian data suggests risks remain tilted towards further USD/CAD strength.
