USD/CAD: downtrend at risk post BoC on rising net-short trades

Canadian dollar, USD/CAD, IG client positioning talking points

• Rising USD/CAD net-short positioning undermining downtrend
• Fading momentum hints more confirmation needed under $1.3069
• Canadian dollar may look past soft CPI data for external risks

Canadian dollar IG client sentiment outlook - bullish

After experiencing the best month against the US dollar since January, risks for the Canadian dollar appear to be tilting to the downside. Accompanying the over 3.4% decline in USD/CAD last month was an uptick in Canadian dollar net long positioning, indicated by IG client sentiment (IGCS) on the first chart below. At one point, roughly 67% of loonie traders were biased to the upside.

Since then, changes in positioning warn that the current USD/CAD price trend may soon reverse higher despite the fact that traders remain net long. We typically take a contrarian view to crowd sentiment, meaning that since traders are net long suggests that USD/CAD prices may continue their path lower. From a psychological perspective, this points to traders attempting to pick where the loonie may bottom.

However, this is occurring at a decreasing pace. The number of traders net short as of July 15 is 17.5% and 50% higher compared to July 12 and a week ago respectively. If traders resume adding exposure to USD/CAD longs, the outlook could shift bearish again.

USD/CAD client positioning

USD/CAD technical analysis - downtrend momentum fading?

USD/CAD finds itself attempting to extend the dominant downtrend from June. Its decline was initiated via a shooting star after prices peaked at $1.3565. With confirmation via further closes to the downside, that candlestick pattern can mark turning points in uptrends. In this case, it was the one that took USD/CAD from $1.3069 in February to the 31st May peak after an inverse head and shoulders pattern.

Now, the February low gave way as support at $1.3069. Confirming further daily closes to the downside opens the door to setting new 2019 lows. In such a scenario, levels of support may bring declines to a pause at $1.2982, $1.2888 and $1.2783. Those are lows that formed back in August and September 2018. However, positive relative strength index (RSI) divergence is present and this shows fading momentum to the downside.

At times, this can precede a reversal or translate into consolidation. In the event of a turn higher, the pair could come across what appears to be potential descending resistance (parallel pink lines on the chart below). Clearing them exposes former support, a range between $1.3251 and $1.3291. That could reinstate itself as resistance, creating a challenge to reverse the dominant downtrend that took USD/CAD over 3.8% lower since June.

USD/CAD daily chart

Canadian dollar fundamentals – post BoC

Taking a look at Canadian dollar fundamentals helps to explain its impressive performance against the greenback as of late. On the next chart below, we can see that gains in Canadian dollar occurred alongside continued outperformance in Canadian economic data outcomes relative to economists’ expectations. This is shown via the Citi Economic Surprise Index that tracks Canada.

This is as opposed to deteriorating results from the United States, China and even Australia. While this has helped to fuel aggressive US Federal Reserve (Fed), People's Bank of China (PBOC) and Reserve Bank of Australia (RBA) interest rate cut expectations, those tracing what the Bank of Canada (BoC) might do next have softened. This is indicated via the red line on the chart below, which looks at where the BoC may take rates by year end as implied by local bank bill futures.

At July’s interest rate decision, the BoC left rates unchanged as expected at 1.75% without hinting of an imminent cut on the horizon. Policymakers deemed the setting of where they currently are as 'appropriate'. While they envision inflation returning to target by mid-2020, they noted that downside risks include trade conflicts as they keep a close eye on upcoming data.

As such, a disappointment in June’s inflation report may do little to fuel BoC rate cut bets this year as policymakers anticipate a temporary dip in consumer price index (CPI) ahead on temporary factors such as gasoline prices. The fundamental focus for the Canadian dollar may likely remain on external risks such as global growth fears pushing down crude oil prices and the potential of US dollar gains should a premium for liquidity arise.

Canadian dollar trading resources

• See how the Canadian dollar is viewed by the trading community at the DailyFX Sentiment Page
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