USD/CAD forecast: BoC, Fed and the carry trade opportunity

The USD/CAD exchange rate stabilized after Donald Trump’s inauguration and as investors waited for the upcoming Federal Reserve and Bank of Canada (BoC) interest rate decisions. It was trading at 1.4345, a few points below this month’s high of 1.4520. So, is it the end of the USDCAD rally?

BoC interest rate decision

The BoC interest rate decision will be the key catalyst for the USD/CAD pair. It will set the tone for what to expect this year.

Economists expect the BoC to cut interest rates again by 0.25%, a move intended to support a slowing economy.

The BoC has become one of the most dovish central banks in the market in the last 12 months. It has already slashed rates from last year’s high of 5.50% to 3.25%, a trend that may continue this year.

Economic data released last week showed that the headline Consumer Price Index (CPI) dropped to 1.8% in December from 2.0% in October. It has fallen from the post-pandemic high of 8.1% and is now below the BoC’s target of 2.0%.

Another report released late last year showed that Canada’s economy grew by 0.3% in the third quarter, the slowest increase in years. It expanded by 0.5% in the first and second quarters.

Canada’s slowing economy and higher accommodation costs explain why Prime Minister Justin Trudeau was forced to resign. 

Federal Reserve decision

The USD/CAD exchange rate will also react to this week’s Federal Reserve decision. Economists expect the BoC to maintain a fairly hawkish tone in its first decision under Trump.

That’s because US inflation has remained relatively high in the past few months. According to the Bureau of Labor Statistics (BLS), the headline CPI rose from 2.7% in November to 2.9% in December, moving further from the bank’s target of 2.0%.

The core CPI, excluding the volatile food and energy prices, slowed from 3.3% to 3.2% during the month. 

The US unemployment rate is still high as it moved from 4.2% in November to 4.1% in December. Therefore, the bank will likely maintain rates unchanged as it waits for more data.

The Fed and BoC decisions will have a big implication in terms of carry trade. A carry trade is a situation where investors borrow money at low interest rates and invest in higher rates ones. 

In this case, the BoC cut will bring Canada’s benchmark rate to 3.0%, while the Fed will leave its rates at 4.50%. That will widen the spread, making it an ideal carry trade.

USD/CAD technical analysis

The daily chart shows that the USD to CAD exchange rate has moved sideways in the past few days. It peaked at 1.4515 this month and then pulled back to 1.4343. The pair has formed a falling broadening wedge chart pattern, a popular reversal sign.

It has also formed a bullish flag pattern comprising of a long vertical line and a rectangle. In most periods, this pattern usually leads to a strong bullish breakout. The pair also remains above all moving averages. 

Therefore, the USD/CAD pair will likely keep rising as bulls target the psychological point at 1.4600. 

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