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Abstract: The Bank of Canada unexpectedly raised the overnight rate by 25 basis points to 4.75% and indicated its commitment to continue implementing quantitative tightening (QT) to support the Canadian dollar.

Fundamentals

The Bank of Canada restarted its tightening cycle yesterday to support the Canadian dollar, pushing the USDCAD lower for a second straight day to a near four-week low near 1.3380. Meanwhile, a good recovery in crude oil prices supported the commodity-linked Canadian dollar, which, along with fresh selling around the U.S. dollar, exerted downward pressure on the pair.

The Bank of Canada has given many reasons for restarting the tightening cycle. Among them was stronger-than-expected economic growth in the first quarter, thanks to strong consumer spending. Moreover, the unexpected rise in inflation in April, five consecutive months of unemployment stability at historic lows, and signs of the end of the Canadian real estate adjustment all contributed to the decision.

We believe the Bank of Canada may have to wait until July to gather more data and update its forecasts, but in line with the aggressive stance throughout the tightening cycle, the Governing Council's 25-basis-point rate hike still surprised the market. Although Bank of Canada Governor Tiff Macklem's statement at his mid-May press conference did not sound eager to raise rates—focusing on broader CPI trends rather than the April blip and downplaying the rebound in the housing market—the policy statement from yesterday appears to justify the rate hike. The key message from the CBC was that "excess demand in the economy appears to be more persistent than expected" and that there is a growing risk that inflation "could be significantly above the 2% target".

In addition, recent U.S. inflation and labor market data releases have kept hopes alive for a 25-basis-point Fed rate hike in June. However, dovish comments from several Fed officials last week raised bets that the Fed's policy tightening cycle is about to be suspended. This led to a further decline in U.S. Treasury yields and put U.S. dollar bulls on the defensive. Meanwhile, the upside for oil prices appears limited due to concerns that a global economic slowdown will weaken fuel demand. Current traders are likely to avoid big bets, which could increase the likelihood of another surprise rate hike before further clarity on the Bank of Canada's policy. The Bank's latest monetary policy, along with oil price dynamics, should be expected to influence the Canadian dollar and provide cyclical short-term trading opportunities for the USDCAD.

Technical Analysis

After the Bank of Canada's hawkish interest rate hike announcement on Wednesday, the USDCAD pair experienced a third consecutive day of decline, nearing a one-month low. The market viewed the Bank of Canada's comments as a hawkish signal and boosted expectations for another rate hike next month, providing more support for the Canadian dollar.

The daily chart shows that bears have taken full advantage of the downward momentum and multiple death cross signals formed by moving averages (MA), targeting the key near-term support at 1.3314. A breakthrough of this support level would open the path towards 1.3224, which is the bottom of a larger range since November.

However, the oversold condition in the daily chart warns the bears that any further declines should be moderated, as the asset's cyclical rally characteristics still allow for a possible resurgence of the bulls before breaking the previous low. In terms of strategy, it is recommended to buy the dips while using a trailing stop-loss based on the previous low.

Trading Recommendations

Trading Direction: Long

Entry Price: 1.3350

Target Price: 1.3570

Stop Loss: 1.3280

Valid Until: 2022-06-22 23:55:00

Support: 1.3320, 1.3301, 1.3262, 1.3224

Resistance: 1.3396, 1.3460, 1.3480, 1.3510