By Michael O’Neill
Canadian consumers are facing plenty of shortages in the early days of 2022. There are shortages of many items including, new and used cars, intensive care beds, nurses, emergency workers. Business owners are complaining that they can’t find employees.
But there are no shortages of foreign exchange forecasts and currency outlooks.
Former Fed Chair Alan Greenspan had this to say about FX predictions, in a speech March 2, 2004.
“My experience is that exchange markets have become so efficient that virtually all relevant information is embedded almost instantaneously in exchange rates to the point that anticipating movements in major currencies is rarely possible. The exceptions to this conclusion are those few cases of successful speculation in which governments have tried and failed to support a particular exchange rate.
His words are as relevant today as they were nearly eighteen years ago.
Nevertheless, if your portfolio or company has a foreign currency exposure than you need to have a view.
Source: Flickr and Rush
USDCAD is currently trading at 1.2730. Forecasters are predicting a1.2000-1.3100 range in 2022. It is not much of a guess as it is almost identical to the 2021 trading band.
Reasons for Canadian dollar strength
Economic growth: Canada may experience sluggish economic growth in Q1 2022 thanks to the Omicron variant sparking renewed retail restrictions and work-from-home orders in some provinces. Some forecasters expect a robust recovery with Q2 and Q3 growth at 8.0% and 7.0%, respectively.
Global recovery: USDCAD is expected to be pressured when the Omicron variant runs its course and the global recovery takes hold, which implies increased commodity demand.
Oil: OPEC and friends raised their forecast for oil demand by 1.11 million barrels per day in Q1 2022. Goldman Sachs analysts appear to agree. They predict a new high in oil demand and warn the WTI price could hit $100.00/barrel. One of the reasons for the price gain is that inflation is raising prices in the oil services area.
Reasons for Canadian dollar weakness
Omicron: The highly contagious COVID-19 variant threatens to overwhelm hospitals in major cities. Ontario and Quebec have reverted to draconian measures, including closing schools, banning indoor dining, closing gyms, and limiting indoor gatherings to five people. The moves will certainly derail economic growth in Canada’s two most populous provinces, weighing on 2022 GDP growth.
Bank of Canada: The Omicron outbreak may force the BoC to delay raising interest rates if the provincial restrictions increase unemployment and lower inflation.
Oil: The WTI rally stalled in October at $85.00/barrel and since then, prices have remained below $80.00/b. Omicron saw the renewal of travel bans and restrictions worldwide, suggesting that higher oil demand would be delayed. A drop below $65.00/b would fuel USDCAD demand.
Trade Disputes: Canada is embroiled in two major trade disputes with the US, and there is a third one waiting in the wings. In November, the Americans slapped punitive tariffs on softwood lumber, and in December, Canada lost a trade challenge over dairy subsidies. President Biden’s Build Back Better plan includes electric vehicle subsidies risk severe damage to Canada’s automotive industry.
The Fed: The FOMC minutes from the December 15 meeting indicated the first rate hike could occur in March, the same time QE ends.
Many analysts expect the Fed to raise rates more aggressively than the market, which would outpace BoC rate hikes if accurate.
If so, Wall Street, which started 2022 at a record high, would be vulnerable to a correction leading to a wave of risk aversion. The US dollar would rally due to safe-haven demand and the Canadian dollar would be collateral damage.
Geopolitical issues: Russia has amassed an army on the Ukraine border in protest of NATO’s buildup of troops and missiles. In China, President Xi Jinping is regressing to the cultural revolution policies of Mao Zedong, and he has designs on Hong Kong and Taiwan. Iran continues to be the nitroglycerin in the Middle East-one bad shake, and everything blows up. The Canadian dollar would go boom as well in a risk aversion sell-off.
The Technical Picture
The longer term USDCAD technicals are bullish, with a decisive break above 1.3030, targeting 1.3650. However, a topside break will not be easy. USDCAD has rejected price moves above the 1.2970-1.3030 zone since November 20.
Nevertheless, USDCAD was in a long term uptrend that started in December 2012
and continued the Pandemic 2020 liquidity injection, drove interest rates to near-zero and boosted commodity prices and commodity currencies.
Fibonacci retracement analysis of the 2020-2021 range suggests that a decisive breach above 1.3030 (38.2% retracement level) targets 1.3650. (61.8%)
Chart: USDCAD weekly with Fibonacci retracement highlighted
Source: Saxo Bank
Conclusion: The consensus forecast from most Canadian banks suggests that USDCAD will weaken to somewhere in the 1.2000-1.2350 area. If that is your bias, and you have USDCAD to sell, it makes sense to put some hedges on at current (1.2750) levels, with the assumption that USDCAD tops out in the 1.3000-1.3030 area.
For those needing to buy US Dollars and are worried about a topside rally, buying USDCAD hedges on dips in the 1.2600-1.2650 area may be prudent.
Keep in mind that USDCAD has tracked broad US dollar sentiment for most of the 2020 and 2021. Bullish and bearish domestic economic data rarely has a lasting impact on prices as the major G-10 currencies dance to the US dollar tune. Why should 2022 be any different?
Everyone should take FX forecasts with a large grain of salt. Mr. Greenspan agrees. He said, “despite extensive efforts on the part of analysts, to my knowledge, no model projecting directional movements in exchange rates is significantly superior to tossing a coin.”