USD/CAD Relationships Suggest Downside

Daily Forex Technicals | Written by Forex.com | Mar 28 12 19:37 GMT

We have recalculated our USD/CAD regression model after a change of inputs which has increased the explained variation in the exchange rate. Our regression model now has an R-squared of 0.87, indicating a stronger degree of explanatory power by the model from the previous R-squared of 0.71. We maintained the U.S.-Canadian 2-year government yield differential and the S&P 500 as independent variables. As oil has reached elevated prices, the relationship between oil and USD/CAD has diminished and therefore this input was removed and replaced by the price of copper. Analysis shows that copper is a statistically significant variable and the current correlation between the metal and the exchange rate (-0.6312 using a 30-day rolling correlation of daily % changes) is stronger than the exchange rate’s correlation with oil (-0.4934).

While the inverse correlation between USD/CAD and WTI crude has been stronger at times it is less stable than the correlation between copper and the exchange rate (see exhibit 3). The correlation between USD/CAD and WTI tends to deteriorate when oil is above $100/barrel.

The model suggests a current value of 0.9840 for USD/CAD which is around the lows of 2012. The current spot rate is just below parity, indicating the potential for downside. We note that the spread between the spot rate and the model’s value has been significantly higher in the past indicating the risk that the model and exchange rate continue to diverge (model lower, rate higher. See exhibit 2).

We favor a move lower and technical analysis supports our view as well as USD/CAD approaches a key resistance level (see chart below). The 200-day SMA and trendline resistance converge around the psychological parity level which is likely to be a pivotal level in the near term. Furthermore, the daily RSI indicator is testing a horizontal resistance level that has contained the oscillator throughout 2012. A move above the 1.000 big figure in USD/CAD may see towards the horizontal resistance level around the 1.0050 area while a sustained break above that resistance level would negate our bearish view.