US Dollar - Canadian Dollar Interest Rate Forecast

US Dollar - Canadian Dollar Interest Rate Forecast : Markets expect the Bank of Canada to be the most aggressive in 2011, as they price in 82 bps in tightening compared with the next closest at 55 bps. The yield spread between the “loonie’ and the greenback has risen to 59 bps making the case for further USD/CAD weakness. The pair has pushed below parity which it has failed to hold below in the past as Canada’s ties to the U.S. economy makes an argument against a stronger domestic dollar.

However, crude prices remain the main driver of price action for the pair with the two holding an 80% correlation. Firm risk appetite continues to be supportive for oil and the “loonie”. Traders should guard against a shift in sentiment due to broader factors such as a reemergence of concerns over the European debt crisis.

US Dollar / Canadian Dollar Valuation Forecast
The disparity between USDCAD and its PPP-implied exchange rate widened in December, Canadian Dollar now 16.9 percent overvalued relative to its US counterpart. The recent pickup in US economic data is undeniably good news for Canada – which sends close to 80 percent of its exports to its northern neighbor – hinting at ample scope for renewed rate hikes. Indeed, current consensus forecasts suggest that the gap in benchmark interest rates is will shift by a further 75 basis points in the Canadian Dollar’s advance over the course of 2011, with only the New Zealand Dollar being promised an equally robust monetary policy landscape. As such, the current disparity may continue to widen for the time being before a correction materializes. All told, while a strictly valuation-based analysis calls for a bullish bias for USDCAD, now does not seem like the opportune time to express it.

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