USD/CAD Susceptible to Larger Correction Ahead of US CPI, FOMC Minutes

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Canadian Dollar Talking Points

USD/CAD has taken out the August low (1.2453) following the better-than-expected Canada Employment report, but key developments coming out of the US may curb the recent decline in the exchange rate as signs of sticky inflation may put pressure on the Federal Reserve to normalize monetary policy sooner rather than later

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USD/CAD Susceptible to Larger Correction Ahead of US CPI, FOMC Minutes

USD/CAD extends the series of lower highs and lows from last week as Canada’s labor market returns to pre-pandemic levels, with the economy adding 157.1K jobs in September, which helped to push the Unemployment Rate to 6.9% from 7.1% in August.

Image of DailyFX Economic Calendar for Canada

According to Statistics Canada, “the labour force participation rate was 65.5% in September, matching the rate observed in February 2020,” and signs of a robust recovery may encourage the Bank of Canada (BoC) to adjust the forward guidance for monetary policy as officials “expect the economy to strengthen in the second half of 2021.” As a result, the Canadian Dollar may continue to outperform its US counterpart ahead of the next BoC interest rate decision on October 27 as Governor Tiff Macklem and Co. pledge to “provide the appropriate degree of monetary policy stimulus to support the recovery and achieve the inflation objective,” but key developments coming out of the US may prop up USD/CAD as the Federal Reserve appears to be on track to switch gears later this year.

Image of DailyFX Economic Calendar for US

Signs of sticky inflation may put pressure on the Federal Open Market Committee (FOMC) to normalize monetary policy sooner rather than later as both the headline and core Consumer Price Index (CPI) are anticipated to hold steady in September, and the weaker-than-expected Non-Farm Payrolls (NFP) report may do little to derail the central bank from scaling back monetary support as “bottleneck effects have been larger and longer lasting than anticipated, leading to upward revisions to participants inflation projections for this year.”

In turn, the FOMC Minutes may generate a bullish reaction in the US Dollar as Chairman Jerome Powell and Co. lay out a tentative exit strategy, but a further decline in USD/CAD may fuel the tilt in retail sentiment like the behavior seen earlier this year.

Image of IG Client Sentiment for USD/CAD rate

The IG Client Sentiment report shows 74.35% of traders are currently net-long USD/CAD with the ratio of traders long to short standing at 2.90 to 1.

The number of traders net-long is 3.42% higher than yesterday and 14.07% higher from last week, while the number of traders net-short is 25.55% higher than yesterday and 7.28% lower from last week. The rise in net-long position has fueled the crowding behavior as 47.19% of traders were net-long USD/CAD during the last full week of September, while the decline in net-short position comes as the exchange rate trades to a fresh monthly low (1.2446).

With that said, USD/CAD may face a larger correction following the failed attempt to test the yearly high (1.2949) as it takes out the August low (1.2453), but signs of sticky inflation in the US may generate a bullish reaction in the Greenback as it fuels speculation for an imminent shift in Fed policy.

USD/CAD Rate Daily Chart

Image of USD/CAD rate daily chart

Source: Trading View

  • Keep in mind, the break above the January high (1.2881) indicates a shift in the broader trend as an inverse head-and-shoulders formation takes shape, with the 50-Day SMA (1.2623)reflecting a positive slope as USD/CAD pushed to a fresh yearly high (1.2949) in August.
  • However, USD/CAD appears to have reversed course following the failed attempt to test the yearly high (1.2949), and lack of momentum to defend the August low (1.2453) raises the scope for a larger correction as the exchange rate carves a series of lower highs and lows.
  • A break/close below the Fibonacci overlap around 1.2410 (23.6% expansion) to 1.2440 (23.6% expansion) to open up the 1.2360 (100% expansion) region, with a break of the July low (1.2321) opening up the 1.2140 (50% expansion) area.
  • Need a move back above the 1.2510 (78.6% retracement) region, which lines up with the 200-Day SMA (1.2509), to bring the topside targets back on the radar, with the next area of interest coming in around 1.2620 (50% retracement) to 1.2650 (78.6% expansion).

— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong

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