"The dual employment reports out Friday may or may not be a catalyst for that type of move" - BMO Capital Markets

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The Canadian Dollar clawed its way near to the top of the major currency league table in the opening week of the New Year but its rally has pushed USD/CAD below an estimated 'fair value' and prompted an often-reliable BMO Capital Markets financial model to recommend selling the Loonie as a result.

Canada's Dollar rallied against all counterparts in the G10 basket this week, leaving it vying with the U.S. Dollar for the top spot among major currencies thus far in the fledgling year of 2023, though the decline in USD/CAD may have run about as far as it's likely to for the time being.

"The signal was issued because spot USDCAD dipped below the model's fair value at a juncture when the model interprets fair value as generally trending higher," writes Greg Anderson, CFA, PhD and global head of FX strategy at BMO Capital Markets, in a Wednesday research briefing.

"Many model signals only last for a day or two. With spot relatively near to fair value, that may be the case this time. The signal will be exited if spot USDCAD rallies back above fair value over the next few days. The dual employment reports out Friday may or may not be a catalyst for that type of move," he adds.

BMO's model was designed Anderson and suggested 'fair value' for USD/CAD was around 1.3628 on Thursday, meaning it might not remain a buy for long.

Above: USD/CAD shown at hourly intervals. Click image for closer inspection.

USD/CAD fell heavily in mid-week trade amid declines for the U.S. Dollar and market optimism about the outlook for the Chinese economy following a decision in Beijing to abandon attempts at containing the coronavirus.

BMO's model suggests the most influential financial market factors for USD/CAD are currently the trajectory of the S&P 500, the 5Y swap rate differential, and the Bloomberg Commodity Index, all of which will be sensitive to the details of employment data out in the U.S. and Canada on Friday.

"We look for employment to rise by 8k in December as the Canadian labour market starts to cool. This should push the unemployment rate back to 5.2%, although we expect full-time employment to drive the headline print," says Andrew Kelvin, chief Canada strategist at TD Securities.

"We also look for wages to push higher to 5.5% y/y with help from muted base effects, while hours worked should see a modest increase," Kelvin adds.

Investors and traders will likely scrutinise Friday's job data closely after the Bank of Canada (BoC) said in December that it would spend the subsuquent months "considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target."

Above: USD/CAD shown at daily intervals alongside U.S. Dollar Index. Click image for closer inspection. If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.

Financial markets have since marked down their expectations for further increases in the Canadian cash rate though that could change if rising employment continues to drive pay settlements higher as the market and BoC would likely view that as an inflation risk.

"This will be an important data release. NFP reports are likely to receive elevated focus given the nascent turn in inflation and the emphasis on tight labor markets/sticky wages from the Fed," says Mazen Issa, a senior FX strategist and TD Securities colleague of Kelvin.

"Our above consensus jobs forecasts has us looking for a short-term USD bounce against the majors. We see some bearish technical signs for EUR and JPY vs the USD," Issa writes in a Thursday reference to the non-farm payrolls report due out in the U.S. on Friday.

While USD/CAD will be sensitive Canada's employment figures ahead of the weekend, it will also have to navigate a U.S. job report from which many expect to see a further bumper increase in employment for December with possible implications for Federal Reserve policy.

Just like the BoC, the Fed is seeking to reduce corporate demand for labour and to soften up the labour market using its interest rate in a bid to drive U.S. inflation rate to the 2% target, which is widely expected to result in U.S. interest rates rising above 5% in the months ahead.

Above: USD/CAD shown at weekly intervals alongside U.S. Dollar Index. Click image for closer inspection. To optimise the timing of international payments you could consider setting a free FX rate alert here.