What Will The Loonie Do Next?

Summary

• The loonie is meeting support against the dollar at 0.776.
• A surprise rate hike in the United States could mean short-term depreciation in the loonie.
• However, I see the loonie as having long-term growth potential.
• In my opinion, a level of 0.75 would provide significant margin of safety for a long CAD/USD position.

When we take a look at the charts for the CAD/USD, we see that the loonie could be meeting a long-term support level at this point.

1-day chart

1-week chart

1-month chart

At the level of 0.7764 at the time of writing, we see that mid-December was the last time that the CAD/USD was trading at this level. While the CAD remains well below pre-2015 levels relative to the greenback, the loonie has climbed higher since 2016.

In this regard, is there a case for being bullish on the loonie right now?

From a technical standpoint, it could well be the case that the loonie bounces off support and heads back up within the 0.80 range against the dollar.

On a macroeconomic basis, the Bank of Canada is also taking a very cautious approach to raising interest rates. For instance, while an interest rate hike was expected to take place next week, a slowdown in household spending to the lowest rate in two years has prompted caution in doing so. Moreover, while GDP growth in the final quarter of 2017 came in at 1.7 percent, this was still below economist forecasts of 2.0 percent growth.

That said, could we still see a situation where the CAD rises against the USD irrespective of interest rates? In my opinion, it is quite possible. Given that we have seen the CAD/USD descend to a key support level, it is likely that growth and rate hike expectations have already been priced in.

Moreover, a further rate hike in July is being priced in by the markets, while rates have already been raised three times since last July. However, a combination of stationary rates along with the potential for a surprise rate hike in the United States, adding to the three already scheduled for this year. This is particularly the case if wage growth increases faster than expected and unemployment remains below the Fed’s defined potential of 4.3-5%.

This could lead to further CAD weakness for the time being. However, wage growth in Canada is also rising, which could prompt similar action in Canada in terms of raising interest rates. While this may not happen as quickly as in the USA, a rise in rates would ultimately be necessary to keep employment at sustainable levels and prevent excessive inflation.

Therefore, I see the case for a long-term rise in the loonie, even if the currency does come under pressure in the short-term with a surprise rate hike in the States. While rates and growth are on an upward trajectory in the United States, the same can be said for Canada. Should we see the loonie drop to the 0.75 level in the short-term, then I would consider this a significant margin of safety to initiate a long position.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.