Canadian Dollar Underperforms on Fundamental Forecast

Fundamental Outlook for Canadian Dollar: Bearish

- Overextended futures positioning boosts Canadian Dollar Outlook
- Canadian CPI inflation unexpectedly accelerates, boosting interest rate outlook

The Canadian dollar gained sharply against its US namesake on recent Federal Reserve actions, but the Loonie nonetheless underperformed major G10 counterparts on mixed results in domestic economic data. Canadian dollar forecasts remain muted as traders take stock of economic developments in the highly trade-dependent country. Indeed, recent data releases pointed to continued weakness in key export-related industries, and domestic consumption has fallen sharply as a result. Looking to the week ahead, a relatively empty economic calendar promises little in the way of foreseeable event risk. Yet it will be important to watch developments in the US economy and effects on the Canadian dollar.

Canada’s strong dependence on international trade leaves its currency at the mercy of international demand, and forecasts for a global economic recession bode poorly for the downtrodden Canadian dollar. According to 2008 estimates, Canadian exports amount to approximately 30 percent of domestic GDP. Recent January figures show that said exports plunged 18.2 percent on a year-over-year basis. Clearly, a continuation in the ongoing trend will have substantial effects on domestic GDP.

Such bearish outlook for global consumption makes it difficult to feel bullish on the downtrodden Canadian dollar, but its continued resilience against the USD suggests that bulls have not yet given up the fight. Likewise significant, clear downward momentum in the US Dollar could maintain downward pressure on the USD/CAD exchange rate—offsetting relative Canadian Dollar weakness. It will be critical to watch whether US dollar concerns will outweigh clear risks of sustained Canadian economic contraction. – DR