Scotiabank strategists Shaun Osborne and Eric Theoret note the Canadian Dollar (CAD) has gained modest relief as front-end US/Canada spreads retreat about 10bps from last week’s peak, though rate differentials remain punitive. They judge USD/CAD is trading close to their fundamental fair value at 1.4135 and stress that positioning indicators show an extremely overbought US Dollar (USD), implying limited upside and scope for a modest pullback.

Rally seen extremely stretched

"The CAD has found some relief in the past few sessions from the marginal retreat in front-end US/Canada spreads. The 2Y cash bond and swap spreads closed last week some 10bps off the intraday peak seen last Monday, a meaningful move after a sustained widening in rate differentials since the start of May."

"Spreads remain punishing for the CAD, however, and the narrowing seen in the rate differentials so far can only so much to boost sentiment. The reality is that, given where spreads are still, the CAD is trading relatively close to our fundamental fair value estimate today (1.4135)."

"Neutral/bearish—Minor net gains for the CAD through late week trade support the idea of a stabilization at least in its recent decline but there is little evidence of technical strength in the CAD on the short-term charts."

"What there is, however, is ample evidence of the extreme degree of stretch in the USD rally. The daily RSI peaked at near 89 last week, well into overbought territory. The oscillator has not been higher in at least 20 years."

"Spot remains two standard deviations above its 40-day MA. Both indicators point to an extremely overbought USD. That may limit dollar gains to around 1.4250/1.43. A modest retracement could take spot to 1.4075/80."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)