USD/CAD - Canadian dollar looking for Bank of Canada support

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The Canadian dollar has benefited from the strong inflation numbers released this morning, which could push the Bank of Canada to raise rates sooner rather than later. Optimism of a deal on the North American Free Trade Agreement front is also helping the loonie and is a big factor that could also push the Bank of Canada (BoC) to raise rates.

Welcome to the first day of fall. Actually, in Ontario, the first day of fall occurs on September 22 at 9:54 p.m. which is a far more precise calculation that what you can expect from Canadian dollar forecasts. And there is no shortage of forecasts.

The Canadian dollar is expected to finish the year right around where it is currently trading which suggests that another rate hike by the Bank of Canada at its October 24 meeting will have a limited impact.

A rate increase is justified. The Canadian economy is firing on all cylinders and believed to be operating at or above capacity. Core inflation has reached the BoC’s 2.0% target.

Bank of Canada Deputy Governor Carolyn Wilkins spoke in Saskatchewan a few weeks back and gave a relatively upbeat assessment of the Canadian economy. She pointed out that Gross Domestic Product growth, which may be a tad softer in Q3 has underlying momentum. She said the housing market has stabilized after a wide range of policy changes and higher interest rates. However, she tempered her enthusiasm by noting that inflation increases were temporary and that business investment was subdued because of NAFTA uncertainty. Her comment about the BoC discussing removing the forward guidance of the “gradual approach to raising rates” was seen by FX traders on September 6 as a "hawkish" development and it sparked Canadian dollar buying.

Wilkins said that the BoC does not incorporate scenarios that have yet to occur in its financial models. It is safe to assume that if Canada manages to secure a new trade deal with the U.S., Canada will be in a more disadvantaged position under the new agreement that it was under the old NAFTA deal. If so, the BoC outlook would be downgraded which future rate increases pushed further down the road. The Canadian dollar would sink under that scenario.

The Canadian dollar is trading at levels that may be considered overly optimistic in light of the global macro and geopolitical uncertainties. The August Turkish lira crisis and contagion impact on other emerging market currencies should have reminded traders of the fragility of the current economic climate.

Middle East tensions are elevated particularly among the many nations involved in the Syrian conflict. Also, U.S. President Trump’s sanctions on Iran have angered that nation, and it has even threatened to disrupt global shipping through the Strait of Hormuz. China is still making encroachments throughout the South China Sea. On Tuesday, a Japanese submarine was openly defying China’s claims over that body of water. It is easy to see how an incident could turn nasty.

Traders may be looking for the Bank of Canada to give more support to the Canadian dollar, but trade and global developments may prevent the BoC from being overly hawkish.

Rahim Madhavji is the President of KnightsbridgeFX.com, a Canadian currency exchange that provides better rates than the banks to Canadians