Currency In Focus: CAD Sales Overdone; NAFTA Concerns Overstated

By Shant Movsesian and Rajan Dhall MSTA FXDailyterminal.com

While this week's focus will be on the FOMC and the Brexit talks, we see both the USD and GBP off their respective extremes, and as such will take a quick look at the CAD, which was the clear underperformer last week.  Largely based on fears of a breakdown of the NAFTA accord, we have see USD/CAD pushing through the 1.3000 level this week, but suffering heavy losses against the likes of the EUR, JPY and GBP - the latter now pushing to highs seen in the aftermath of the Brexit vote - still.  

The domestic data has also been fading in recent months, with H2 2017 clearly showing a deceleration of economic expansion which led to the BoC hiking rates twice last year to reverse the accommodative moves on 2015 and once more at the start of the year to push the cash rate to 1.25%.   The CAD rate vs the USD fell to lows in the mid 1.2000's, with a heavy dose of broad based weakness in the greenback, but since recovering, we have seen very little positive differentiation based on rate spreads, which in fairness, look to have broken down across the board.  The spot rate is now pretty much where we started before the BoC embarked on its tightening bias last year, and with technical metrics all pointing to oversold levels, the fundamental backdrop is now getting stretched from what we assume to be significant enough liquidation which is pushing the CAD to the bottom of the (G10) currency pile.  

While again, we look to avoid any political leaning or inclination, our views on the NAFTA accord remain unchanged.  That is, any agreement or collapse will be equally beneficial or negative for the respective parties, based on the economic benefits enjoyed for all 3 nations, albeit to varying degrees - and this is the basis on which the US is keen to redefine terms.  At present however, we continue to see the market pounding on the CAD vs the USD, but also CAD/MXN, which has dropped from 15.70+ highs down to 14.27 in the past week.    While Canada's exports to the US (as of 2016) stand at a little over 55%, Mexico's share to the US is just over 80%, so based on NAFTA risk alone, if is fair to say that on this parameter CAD sales are overdone.  

Even so, the convoluted nature of supply and production chains, rules of origin and cross border to-and-fro suggest the talks will go on through 2018 at the very least, so what we may have to concede is that some of out longer term forecasts for a move back to and through 1.2000 may have to be moderated on risk sentiment alone.   As it is, equity markets have been unnerved by the shakeout seen in stocks in February, so we are anticipating some form of negative skew to the commodity linked currencies over coming months.  

Back 'home' so to speak, the BoC continues to highlight the cautious approach going forward, but one which you would expect after the series of tightening seen so far.  As constantly reminded, there is a period of assessment on how the economy fares with higher rates, but despite regional falls in house prices, and little consumer fall-out to note as yet despite worrisome levels of household debt which have clearly flagged. Capacity utilisation is also rising, and now stands at 86.0%, so with the positive outlook on business investment and bilateral trade with Europe now secured, is the blanket CAD selling justified?.  As noted above, we are close to pricing out rate moves seen so far, though benchmark (10yr) spreads with Treasuries widening out again.  If analysts cite this for currency weakness, then the natural urge will be to start looking a further gains in the USD, but we expect this to unfold - as it is threatening to do - across the board against the likes of the EUR and JPY, and at some point vs GBP.

Extended GBP/CAD levels look an attractive route to reflect a CAD comeback once the Brexit excitement is out of the way this week, given hopes of a transition deal are the significant driving force here and are thoughts on this were covered last week.  Technically, we are close to reaching a cluster of resistance levels from 1.8300-1.8500, and is an area we expect to see value seekers jumping in.  

EUR/CAD is also at extended levels on the short term time frames, as it is against the JPY, but having noted the underperformance against MXN based on skewed NAFTA based sentiment, we have already seen some moderation against AUD and NZD.   Plenty of risks to note over the longer term as there are for most of the major economies in the world; we can't see why the CAD has suddenly turned into the runt of the litter given the level of comparative risks seen elsewhere.