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Short bets on the Canadian dollar are near their highest in five years, with the U.S. and Canada expected to reach 1.3130 in one year
2024-01-02
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The Canadian dollar ended the 2023 trading year almost identical to its opening price at around 1.3550 at the beginning of 2023, fluctuating between 1.3000 and 1.3900 most of the time.
For much of 2023, the Canadian dollar has moved in tandem with volatile crude oil prices and been under pressure from the Bank of Canada, which has kept interest rates unchanged since July 2023 as the Canadian economy contracts. Forecasting into 2024, analysts believe that the Bank of Canada’s interest rate differential with the Federal Reserve, continued correlation with crude oil, and economic headwinds will be key factors affecting the Canadian dollar.
USD/CAD drivers in 2024
Canadian and global economic slowdown
Simon Harvey, head of foreign exchange analysis at Monex Europe and Monex Canada, said, "The Canadian dollar will face difficulties in the next three months as data starts to show that the Canadian economy is on the edge of recession, if not a mild recession."
The Canadian economy is expected to contract further in 2024 after narrowly avoiding two consecutive quarters of recession.
The latest data from Statistics Canada shows that the Canadian economy was basically flat in October 2023, while GDP in September was revised down to zero growth. At the same time, U.S. economic growth remains relatively strong.
Canada’s unemployment rate continued to climb in 2023, approaching 6% in November. In contrast, the employment rate in the United States is currently about 3.6%.
Household debt-to-GDP ratios have declined steadily in both the U.S. and Canada over the past two years, but as Canadian household debt remains at 103% of GDP, the U.S. private debt-to-GDP ratio fell to 74% in the second quarter of 2023 Below, Canadian households remain at risk of a recession.
Of course, one of the important implications of Canada's economic slowdown versus the U.S.'s relative strength is the market expectation and possibility that the Bank of Canada will cut interest rates faster and more aggressively than the Federal Reserve.
Differences in central bank policy
Stéfane Marion and Kyle Dahms of the National Bank of Canada said, “Looking ahead, we are not optimistic that Canada is more likely to adopt a more aggressive interest rate cut policy relative to the United States given our forecast of a global economic slowdown and weak domestic demand. Yuan’s support.”
The Bank of Canada and the Federal Reserve are largely in lockstep in 2023, with both central banks reaching what is widely seen as their ultimate interest rate in the third quarter. As of the end of 2023, the base interest rates of the Bank of Canada and the Federal Reserve are 5.0% and 5.5% respectively.
However, in 2024, the market expects policy divergence as the U.S. and Canadian economies move in different directions.
With the Canadian economy weakening, money markets are pricing in about a 25% chance of the Bank of Canada cutting interest rates early in January, and a 50% chance of a rate cut in March. The possibility of a rate cut in April is fully priced in.
These expectations are largely supported by Bank of Canada policymakers, including Governor Macklem. In early December 2023, McCallum noted: "The tightening of monetary policy is working, and interest rates may now be high enough to get us back to price stability." He also noted: "Excessive demand in the economy has led to rising prices. The element of being too easy is now gone."
As for the Fed, the market expects a rate cut as early as March. Comments from Fed policymakers, however, provided little support for these expectations.
crude oil correlation
FX Street analyst Joshua Gibson said, "Although there has been speculation in recent years about the possible volatility in the relationship between the Canadian dollar and crude oil, the correlation between the Canadian dollar and crude oil is expected to remain solid in the upcoming trading year..."
Although the Canadian dollar has seen a slight decoupling from crude oil prices in the second half of 2023, with the Canadian dollar rising on weaker crude oil prices, the historical correlation between crude oil prices and the Canadian dollar is expected to be the main driver in 2024.
The Canadian dollar generally benefits from higher crude oil prices in two ways: by boosting Canada's trade and current account balances, and by having a net positive impact on the Canadian economy through increased business investment by oil companies.
In 2024, headwinds to crude oil demand are expected to have an adverse impact on the Canadian dollar as the Canadian economy and global growth slow down.
A “less creative” alternative forecast for USD/CAD
Analysts at ANZ are among those expecting a stronger Canadian dollar in 2024 amid a weaker dollar and lower U.S. earnings, assuming the Bank of Canada and the Federal Reserve will ease monetary policy at the same time. "The biggest drivers for USD/CAD are likely to be the overall trend in the U.S. dollar (which we expect to weaken as U.S. growth slows) and the relative change in Canadian and U.S. long-term bond yields," they said.
"In the absence of new specific drivers, a weakening U.S. earnings environment and a weaker U.S. dollar should pull USD/CAD lower," they noted.
Analyst expectations for USD/CAD
The median of 35 foreign exchange analysts surveyed by Bloomberg showed that analysts expect the Canadian dollar to strengthen moderately against the U.S. dollar over the next three months.
The poll, conducted from Dec. 1 to Dec. 5, showed analysts expect the Canadian dollar to strengthen 0.4% against the U.S. dollar over the next three months, reaching $1.3533, up from $1.3450 in the November poll. .
The Canadian dollar is expected to rise to $1.3130 in one year's time, down from the November forecast of $1.3000.
Short bets on Canadian dollar near five-year high
Brad Bechtel, global head of foreign exchange at Jefferies LLC's New York headquarters, said, "As inflation continues to be stubborn and growth is weak, the short base for the Canadian dollar remains quite large."
Meanwhile, speculators' short bets on the Canadian dollar have risen to their highest level in nearly five years, according to data from the Commodity Futures Trading Commission.
According to the data, leveraged funds increased their bets on the Canadian dollar to 51,971 contracts in the week ended December 19, the highest level since January 2019.
The above information is provided by special analysts and is for reference only. CM Trade does not guarantee the accuracy, timeliness and completeness of the information content, so you should not place too much reliance on the information provided. CM Trade is not a company that provides financial advice, and only provides services of the nature of execution of orders. Readers are advised to seek relevant investment advice on their own. Please see our full disclaimer.
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