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The Canadian dollar is making a U-turn after gaining around 2200 pips against the greenback since January. The team at Nomura turns bullish on USD/CAD – seeing more negative moves for the loonie:

Here is their view, courtesy of eFXnews:

USD/CAD has fallen significantly in recent months because of the recovery in oil prices and a weak USD, reaching a low of 1.246 earlier this week. However, over the past few days, USD/CAD has increased sharply, gaining almost 3%.  Before answering whether this marks a turning point for USD/CAD, we make the following observations:

1-  Risk sentiment has worsened recently with global equity markets underperforming. This risk-off environment has put some pressure on other commodity currencies and has provided some support to USD.

2-  Despite increased risk aversion, there has been very little change in the price of oil, with WTI about $1.50 below its recent peak of $46.50. Some of the increase comes because of an expected fall in US oil inventories owing to lower Canadian and US production (more on Canadian oil production below). While higher oil prices should be negative for USD/CAD, the negative impact of the reduction in Canadian production on growth and exports should more than offset the positive impact on the terms of trade.

3-  The recent data out of Canada have been weak. March’s trade deficit widened to C$3.4bn, the widest on record. The deterioration was mainly the result of a sharp decline in exports (-2.9% m-o-m), especially non-energy export volumes (-4.2% m-o-m). The level of export volumes is now back to where it was before the rebound earlier this year. It means that the other data for March are also likely to be weak. While growth in Q1 is likely to be close to 3% q-o-q ar., momentum going into Q2 is very weak, pushing Canadian yields lower.

Canada Non Energy export volumes

4-  Adding to the weak data in Canada, lacklustre data out of the US are signalling that the expected pull from the US economy on Canada could be delayed, suggesting continued weakness in non-energy exports.

5-  Recent positioning data suggest that net long positions in CAD were elevated, the highest since July last year. With economic data likely to remain weak in coming weeks, there is some scope for a reduction in CAD longs.

6-  USD/CAD has been undervalued for some time. Based on current commodity prices and rates differential, we find that USD/CAD should be closer to 1.35. This means that a further correction in coming weeks is likely.

With all this in mind, we believe USD/CAD is likely to continue to move higher. However, the pace will depend on the risk environment, continued strength in the dollar and oil prices stabilising at current levels.

*Nomura targets USD/CAD at 1.35 by the end of Q2.

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