USD CAD – October Forecast

Substantially lower commodity prices helped drive the commodity-sensitive Canadian Dollar lower throughout September. The sharp decline in crude oil, for example, contributed the most to the strength in the USD CAD. Also lending support to the U.S./Canadian’s strength was the turmoil inEurope.

The overall shedding of risky assets on a global scale has led the Bank of Canada to drastically alter its interest rate forecasts in the wake of a possible deterioration in the overall world-wide economy. This forecast for a tightening of the interest rate differential has led some traders to believe that a shift in investor sentiment is taking place and that a major bottom may have been reached in this currency pair. The current rally in the USD CAD has put this currency pair in a position to post a yearly closing price reversal bottom which often signals the start of a long-term rally.

While equity markets may be best to watch because of their strong correlation to movement in the AUD USD and NZD USD, West Texas Intermediate Crude Oil is the market to watch for predicting direction and volatility for the USD CAD during October. The recent decline in crude oil futures triggered a similar decline in the Canadian Dollar. This relationship is likely to remain over the near-term. So while the interest rate differential is an important fundamental development to watch, the correlation between oil prices and the Canadian Dollar offers more significant information.

Besides the price of crude oil’s importance as a leading indicator, traders should also monitor closely central bank activity and inflation news. In September the Bank of Canada announced a dramatic policy shift when it stated that it saw less need to raise interest rates. This was a surprise because it meant that the central bank was adhering to a more cautious stance about the weakening global economy.

Although the Bank of Canada left its benchmark interest rate unchanged at 1 per cent, it took its previous talk of a rate hike off the table. A rate cut wasn’t talked about but traders will have to wait until the next meeting on October 25 to see if the central bank will mention the possibility of a rate cut. Obviously it has time to monitor the situation inEuropebefore reaching a decision.

The main reasons for the dramatic shift in policy are the slowing global economic conditions and heightened financial uncertainty. Basically global economic conditions have shifted so much since the last meeting in July that the central bank cannot continue with its plans to withdraw monetary policy stimulus. With so many traders banking on an interest rate hike by the end of the year in July, these market players had to make a dramatic shift in their strategies by selling aggressively the Canadian Dollar.

With the BoC’s July forecast outdated based on its September statement, the central bank is now strongly indicating that rates will remain unchanged for the rest of the year. This also means that the European debt crisis, slowingU.S.growth and market volatility are going to continue to exert the most influence on the central bank’s decision making process during October. Since these conditions are not likely to change over the next 30 days, the USD CAD should continue to be supported.

Although the Bank of Canada has turned dovish, interest rates are not expected to be slashed at any time soon. Therefore this leads one to conclude thatEurope’s debt issues and falling oil prices will be the key fundamentals driving the direction of the Canadian Dollar throughout October.