The Canadian Dollar (CAD) gained modestly as a weaker US Dollar (USD), firmer risk sentiment, and stronger commodity prices helped lift the currency toward its estimated fair value. With the USD/CAD bear flag broken and spreads narrowing, spot could drift into the low-1.38s in the coming weeks, Scotiabank's Chief FX Strategists Shaun Osborne and Eric Theoret report.

USD/CAD breaks bear flag base, pressures toward 1.3880

"The CAD has taken advantage of the softer USD tone to gain a little ground overnight but the advance is one of the smaller gains seen on the big dollar among the majors. As noted above, risk appetite is mainly positive on the session, even if background concerns remain, while crude prices are a little firmer. Rising Copper prices may give Canadian terms of trade a modest, and CAD-supportive, tailwind."

"The CAD’s main support comes from narrowing US/Canada spreads, with the 2Y swap differential holding below 100bps. Our forecasts anticipate a significant narrowing the Fed/BoC policy spread in the coming year which should be reflected in a further, sizeable contraction in market-driven spreads. Spot losses are bringing the CAD closer to our estimated fair value (1.3982 currently)."

"The USD’s break below the base of the noted consolidation pattern (bear flag) yesterday has dumped spot back to Friday’s low around 1.3940. There should be some additional, immediate downside pressure on the USD towards 1.3875/85 as a result of the break below the flag base (now resistance) at 1.3975. After the November rejections at 1.4140, the CAD’s more decisive push through the upper 1.39 zone could point to additional gains to the low 1.38 area in the next few weeks."