USD/CAD stabilises above 1.2700 as US dollar bulls take a breather

• USD/CAD has stabilised just to the north of the 1.2700 level as USD’s bullish momentum fades.
• Aside from the USD, CAD the next best performing G10 currency on the day.

USD/CAD has stabilised below highs of the day at 1.2730 and above the psychological 1.2700 level in recent trade as bullish US dollar momentum fades. Recent consolidation in the pair is in fitting with price action in the Dollar Index (DXY), which has been moving sideways in an 89.70-89.90 range since midway through the European morning. At present, the pair trades with gains of around 0.4% or close to 50 pips on the day.

Despite trading softer against its US counterpart, the loonie is outperforming most of the rest of its G10 peers (see below for more details).

Markets price in implications of a Democrat-controlled Congress

Markets continue to price in the prospect of much more spending from the US government over the coming months and years under a Biden administration/Democrat-controlled Congress combination. That will likely lead to higher US economic growth and higher inflation, hence why US stocks, nominal US bond yields and US inflation break-evens are higher.

The dollar reaction to the Democrat’s Georgia election victories earlier in the week, which handed them control of Congress, has been thus far positive; DXY is up from under 89.50 to closer to 90.00 as of right now (and thus USD/CAD is up from around 1.2670 to above 1.2700). But things have been choppy and an intense debate as to the longer-term impact of higher US government spending in the months ahead is raging.

The main bullish arguments go along the lines of further fiscal stimulus boosting US growth in 2021 and beyond leading to higher inflation and a more hawkish Fed, while the major bearish arguments are along the lines of more fiscal stimulus leading to higher government and trade deficits and rising bond yields, which put more pressure on the Fed to print money to keep government borrowing costs low.

If the US dollar bulls fail to push DXY above the psychological 90.00 level, the bears may be re-emboldened to push the index back to fresh annual lows under 89.20 and will target the 2018 low at 88.25.

Strong US data helping USD stay afloat

Upbeat US economic data is helping USD retain its status as the best performing G10 currency on the day on Thursday; the December ISM services PMI unexpectedly rose to 57.2 from 55.9 in November versus expectations for a drop to 54.6, despite the higher prevalence of Covid-19 and tougher lockdown restrictions on businesses. The sub-indices were mostly strong, with New Orders rising to 58.5 from 57.2, Business Activity rising to 59.4 from 58.0. Prices eased back slightly to 64.8 from 66.1 and, boding poorly for Friday’s jobs numbers, employment fell back below 50.0 to 48.2.

Meanwhile, weekly US jobs numbers were better than expected, with Initial Jobless Claims in the week ending on 2 January 2021 remaining largely unchanged at 787K versus expectations for a rise to 833K from 790K (revised up from 787K) the week prior. Continued claims for the week ending on 26 December dropped to 5.072M from 5.198M, below expectations for an unchanged reading.

But CAD outperforming the majority of its G10 FX peers

As noted, though lower against the US dollar, the Canadian dollar is trades stronger than the majority of its G10 peers. Given its high dependence on trade with the US, it is unsurprising to see CAD performing well given the Democrat’s recent Senate victory; more government spending in the US will boost the demand for Canadian exports, which will benefit the Canadian economy.

Elsewhere, Canadian trade data for November was a little better than expected, which could be helping the currency; the country’s monthly trade deficit dropped to CAD 3.34B versus expectations for a trade deficit of CAD 3.5B, drive by a slight improvement in exports (which rose to CAD 46.76B from CAD 46.47 last month.

Meanwhile, December Ivey PMI numbers were mixed, with the non-seasonally adjusted figure rising to 53.9 from 52.4 in November but the seasonally adjusted number dropping to 46.7 from 52.7 in November.

Elsewhere, Canada has reportedly launched a new dispute settlement process with the US over "unwarranted" tariffs on its solar products. One would assume that US/Canada trade relations are set to drastically improve under the Biden administration as he takes a softer touch with the US’s western/democratic allies.

The main event of the week for the loonie, however, will be Friday’s official labour market report, which will offer further insight as to how the Canadian economy has been coping with the rising instance of Covid-19. Otherwise, expect USD/CAD to continue to trade as a function of the US dollar.