USD/CAD bears are in control and are targeting a breakout to new cycle lows

At 1.2536, USD/CAD is under pressure and has struck new cycle lows this week, testing the diminishing bullish commitments. As US shares shook off an early risk-off attitude, the US dollar index (DXY) declined against a basket of other currencies. In response, the Canadian dollar rose to its highest level in over seven weeks.

Oil prices have increased and Canadian bond rates have risen further beyond their US equivalents, resulting in a bearish bias for the upcoming trading days. The 10-year yield difference between Canada and the United States expanded by 4.5 basis points to 20 basis points, the biggest since August 2012.

It boils down to economic growth projections and central banks. While the markets anticipate further rate rises from the Federal Reserve, the Bank of Canada has stated that it is prepared to move "more aggressively if necessary" to return inflation to its target level. The Bank of Canada has already raised rates by two straight half-points.

The Financial Stability Report of the Bank of Canada, which is anticipated to shed light on risks and vulnerabilities in the financial system, will keep this issue in the spotlight for the remainder of the week. TD Securities analysts stated that they do not see any consequences for the near-term policy outlook.

We will be on the lookout for any fresh information on high-leverage borrowers or mortgage delinquencies, but we anticipate an overall message that the financial system is robust despite higher interest rates.

On Thursday, we will also hear from Governor Macklem.

Reuters stated that, according to recent statistics, "Canada's trade surplus dropped unexpectedly to C$1.5 billion in April as both imports and exports slowed." However, economists said the slowdown was likely transitory, with supply chain disruptions resolving and oil exports projected to rise.

Canadian economic activity rose at a higher rate in May, according to the Ivey Purchasing Managers Index, while a gauge of employment reached its highest level in 11 months.

Traders will also be watching Friday's jobs data. After a lackluster performance in April, economists at TD Securities predict that the Canadian labor market will rebound in May with 35,000 new positions generated. This reflects an increase in mobility tendencies, a record number of employment openings, and a substantial decline in COVID infections following the post-Omicron wave. A 35k reading would leave the unemployment rate steady at 5.2% (after rounding), but we expect see pay growth in the high 3s.

In a recent note, analysts at RBC Economics stated that "concerns about the Canadian economy's ability to deal with rapidly rising borrowing costs could still exert some downward pressure on the Canadian dollar, which at 79.5 US cents is still well within the roughly 77-81 cent range that has persisted for nearly a year. However, interest rate differentials may not be as significant a currency driver as we originally believed.