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The Canadian dollar can recover against the U.S. dollar as the greenback’s latest rally starts to look stretched, according to TD Securities.
The Canadian bank says in a new note the recent move higher in USD/CAD will prove temporary, "improving Canadian data should allow USDCAD to eventually retrace below 1.40.”
The call comes after a sharp revival in the long-dollar trade, driven by hawkish Federal Reserve repricing and a capitulation of previously bearish USD views.
"The USD’s recent strength was initially driven by hawkish Fed repricing, catalysed by Warsh, which helped revive the long-USD trade," says TD Securities.
That shift has forced investors to chase a move they had previously resisted.
"For much of the past year, investors maintained a bearish USD bias even through periods of geopolitical stress, but higher US rates and growing conviction in a higher-for-longer Fed have forced a capitulation of those views"
TD says the dollar is also behaving more like a classic safe haven again, after last year’s distortions linked to the "hedge America" and "hedge USD" trades.
But the bank doubts the dollar can keep pushing higher at the same pace.
"With DXY approaching 102 resistance, risk reversals normalising, and the uptrend looking stretched, we expect bullish USD momentum to moderate."
That would give the Canadian dollar some breathing room, particularly if domestic data continue to improve.
The bank says sustained dollar upside from here would need a more demanding set of conditions.
“Sustained USD upside would likely require weaker RoW growth and Fed out-hawking market pricing.”
That leaves USD/CAD vulnerable to a reversal if global growth stabilises and U.S. rate expectations stop moving higher.
“As global growth stabilises, risk premia fade, and central banks narrow rate differentials versus a Fed on hold, USD downside should re-emerge later this year.”
For CAD, the near-term challenge is still the dollar’s momentum, but the loonie has a path to recover once the market stops chasing the U.S. rate move and starts giving more weight to improving Canadian fundamentals.