"Earlier today, we bought 3-month EUR/CAD downside and our preference is to run with that trade for now" - CIBC Capital Markets

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Selling Canadian Dollars in the USD/CAD options market had been one of next year's top trades for CIBC Capital Markets just weeks ago but the Loonie's late November sell-off has led the strategy team to book an early eight percent profit and focus instead on betting against the EUR/CAD exchange rate.

Canada's Dollar had been expected to trade in a wide range spanning the gap 1.30 to 1.35 against the U.S. Dollar in the weeks ahead before climbing further in the New Year when the February 28 expiration date of the options involved in the trade would be drawing nearer.

But recent price action in Canadian exchange rates changed the CIBC strategy team's view on what to expect from the Loonie in the weeks ahead while also encouraging it to book a more-than eight percent profit on a bet that USD/CAD would climb heading into the New Year.

"Given the degree by which the CAD remains undervalued against the USD and on the crosses, we feel it’s prudent to monetize the above trade at this point," says Bipan Rai, North American head of FX strategy at CIBC Capital Markets.

"In the near-term, we envisage USD/CAD trading within the 1.32-1.37 range," he adds in a note to clients on Thursday.

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

Last month's Canadian Dollar sell-off saw USD/CAD rallying above 1.36 while other exchange rates like GBP/CAD and EUR/CAD each climbed further and faster in price action that many viewed at the time as the likely one-off impact of a corporate acquisition and disposal.

But the Loonie's recovery had been limited until late this week with USD/CAD remaining persistently higher, keeping the 1.38 strike price on the USD/CAD options tipped by CIBC within reach for a fortnight and prompting the strategy team to look for a rebound from the Canadian Dollar during the weeks ahead.

"Earlier today, we bought 3-month EUR/CAD downside and our preference is to run with that trade for now," Rai says.

"Put simply, EUR/CAD has moved too far to the upside, and has become overvalued. Our in-house factor model (R2 of 0.82) suggests that fair value should be at least 4% lower from here. The technical picture for a move lower looks favourable as well," he had written in an earlier note to clients.

Rai noted on Thursday that EUR/CAD is at its most overbought on some charts since March 2020 and that a retracement to the 1.3638 area "is doable over the coming months" due to the grim outlook for European economies and the relatively good standing of their North American counterparts.

Above: EUR/CAD shown at daily intervals with 200-day moving-average. 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.

"In terms of central bank expectations – markets have the ECB hiking to just above 275bps for this cycle while the BoC is seen pausing at just below 450bps," Rai says.

"For the former, we envisage a terminal rate of 225bps – which is below extant pricing and implies downside risk to the EUR over the coming ECB meeting dates," he adds.

Beyond the Canadian exchange rates CIBC's forecasts envisage the U.S. Dollar partially reversing some of its November losses in the months ahead due to Federal Reserve policy and the deteriorating condition of the global economy.

This is something the Euro and other currencies like Sterling might be more susceptible to than the Canadian Dollar and its North American counterparts but CIBC's year-ahead outlook also anticipates a fresh and more decisive turn lower in U.S. exchange rates further down the line.

"We expect early year strength in the greenback to give way to weakness towards the second half of the year.," Rai says.

"As the winter subsides, we expect green shoots in the UK and Eurozone economies as local price pressures subside. Meanwhile, the Chinese economy should be well into its own re-opening phase by then as well, which will ease pressure on the domestic currency there," he adds.

Above: USD/CAD shown at weekly intervals with GBP/CAD and EUR/CAD. Click image for closer inspection. To optimise the timing of international payments you could consider setting a free FX rate alert here.