Canadian and US interest rate forecasts have remained roughly unchanged through the past several months, giving little reason to take a strong yield-based bias on the USDCAD pair.
A recent Bank of Canada interest rate announcement suggests that Canadian interest rates will remained unchanged, and the Federal Reserve is similarly unlikely to move rates. The disparity between USDCAD spot and PPP-implied exchange rates has narrowed from the extremes but remains significant at over 1800 pips. DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.Learn forex trading with a free practice account and trading charts from FXCM.
Currently modest rate expectations for both the Bank of Canada and US Federal Reserve suggest it will take a noteworthy shift in rhetoric to move the USDCAD through the foreseeable future. USDCAD drifted further into undervalued territory in January, with prices now 17.6 percent removed from their PPP-implied fair exchange rate. The Canadian dollar rallied sharply against the US Dollar through recent trade, as the US Federal Reserve's aggressive interest rate cuts left the Canadian currency at a clear advantage against its US namesake.
Combined with a bearish outlook for Canadian exports, negative Bank of Canada rate expectations leave a pessimistic fundamental bias for the Canadian Dollar.


As we noted last month, "The Canadian Dollar is effectively at purchasing power parity against the US dollar having declined sharply since late September." Looking ahead, a period of undervaluation may be next as interest rate expectations point to substantial rate cuts from the Bank of Canada. The Canadian Dollar has proven far more sensitive to shifts in the Dow Jones Industrial Average and global commodity prices. Thus USDCAD traders would likely do better in tracking crude oil and broader commodity markets as they trade the Canadian currency. While a steadily improving US economy will eventually give the Canadian Dollar an edge over the currencies of other commodity-producing countries where demand is tied to China and Europe, both of which are expected to decelerate through 2013, BOC rate hike expectations have yet to start reflecting that trend. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. The Canadian Dollar currently enjoys a 1.25 percent yield advantage against the Greenback-a fact that has bolstered demand in the otherwise-downtrodden Loonie. And though the Canadian Dollar’s correlation to benchmark oil prices has weakened as of late, we would expect the USDCAD to remain under pressure on continued rallies in energy commodities. With US economic data looking increasingly encouraging and the inflation rate nudging closer to the upper edge of the target band at 3 percent, a further widening of the value disparity seems likely as rate hike expectations mount.


In terms of expectations, however, traders predict that the Canadian currency will lose the vast majority of this yield advantage through 2009. From a valuation standpoint, traders may want to exploit more attractive extremes elsewhere rather than bet on how far USDCAD may deviate and for how long.
This leaves the Canadian dollar in a precarious position, and outlook remains bearish for the Loonie through the foreseeable future. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.



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