The probability of a recession is increasing, which could eventually force the Fed to put on the brakes. How will the decline in US Treasury yields and rising oil prices affect USDCAD? Let’s discuss the topic and make up a trading plan.
Weekly Canadian dollar fundamental analysis
Fear has replaced greed in the financial markets. Investors fear that aggressive monetary restrictions will trigger a global economic recession and wonder whether regulators will slow down rate hikes. The Fed officials have the first word, and until they do so, the US dollar is strengthening. However, the futures market is starting to reduce the estimated value of the federal funds rate at the end of 2022, and the Fed cannot turn a blind eye to this.
The “bad news for the economy means good for the market” scenario suggests that disappointing US macro data could slow down the Fed’s pace, which will benefit the S&P 500. Since the beginning of the year, the US stock index has fallen by almost 20%, while its Canadian counterpart S&P/TSX lost over 9% of its value. The rise of the Canadian stock index is a reason for the flow of capital from the US to Canada, creating favorable conditions for the USDCAD bears.
Dynamics of US and Canadian Stock Indices
What if the Fed really starts raising rates more slowly than expected? Will the reflows of capital to the US begin, which will trigger a USDCAD rally? A slowdown in monetary tightening by the Fed will weaken the US dollar amid the closing of speculative long trades. At the same time, the recession risks will decrease, which will favorably affect oil demand and prices, an important driver of CAD strengthening.
The exclusion of Russia from the oil market, the limited potential of OPEC’s production capacity, and the political crises in Libya and Ecuador indicate a supply shortage. In such conditions, the growth in demand is a key factor in the recovery of the bullish Brent trend and a reason for USDCAD sales.
In my opinion, the Bank of Canada will allow the Fed to be the first to slow down the monetary restriction. Most likely, the futures market will raise the overnight rate by 75 basis points in July to 2.25%. After that, Tiff Macklem and his colleagues are expected to increase borrowing costs by another 100 basis points until the end of 2022. As a result, rates will exceed the upper limit of the neutral level of 2-3%, which does not stimulate or slow down the economy.
Despite the acceleration of inflation to 7.7% in May and the fall in consumer confidence to the lowest level since July 2020, recession risks in Canada are lower than in the US. According to Bloomberg experts, Canada’s GDP will grow by 2% or so over the next few years.
Dynamics of consumer confidence in Canada
Weekly USDCAD and EURCAD trading plan
Falling Treasury yields and a recovery in oil prices will encourage USDCAD and EURCAD sales towards 1.271 and 1.335. The IEA warns that Europe will have to cut its gas consumption by 30% if Russia cuts off supplies. Germany should focus on reducing the use of gas by the country’s industry to replenish reserves. This will negatively affect the European economy and the euro.
Price chart of USDCAD in real time mode
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.