Currency analysts at MUFG expect concerns about the global economy and vulnerabilities due to high levels of domestic debt to undermine the Canadian dollar.

According to the bank, “We recommend a long USD/CAD trade idea to reflect the growing risk of further weakening of the Canadian dollar in the near term amid growing concerns about a sharper slowdown in global growth”.

He recommends buying USD/CAD at 1.2930 with a target of 1.3400.

USD/CAD retreated to around 1.2830 on Tuesday as oil prices posted a net gain and supported the Canadian dollar.

Global growth concerns are important

The Canadian dollar is sensitive to trends in the global economy and tends to rise when the global economy is performing strongly, while it is vulnerable to selling if the global economy deteriorates.

MUFG notes that the Canadian dollar has started to decline amid growing concerns about global growth, which is putting downward pressure on oil and commodity prices.

The bank also sees scope for a further reduction in the growth seen this year, “We see scope for some weakness in the Canadian dollar given that it is the second-lowest among G10 currencies this year.”

Uncertainty in the Canadian housing sector

The Bank of Canada (BoC) raised interest rates by 50 basis points to 1.50% at a policy meeting on June 1. The central bank also said it will fight high inflation decisively by raising rates further.

MUFG, however, is concerned about the state of the Canadian housing sector, especially given the very high debt levels.

According to the bank, “Canada is more vulnerable to a deeper correction in house prices than the U.S., given the size of the housing boom of recent years and high levels of household debt.

If the housing sector comes under pressure, this will also have implications for Bank of Canada policy and interest rates.”

MUFG notes: “This could make the Canadian economy more sensitive to rate hikes than the U.S. economy and limit the Bank of Canada’s ability to keep pace with the Fed in tightening policy.”

It adds: “The Canadian rate market already has a large number of hikes in store, with another 75bp hike expected in July and nearly 200bp expected by the end of the year, which is similar to the Fed.”

If the Bank of Canada is forced to refuse to raise rates, the Canadian dollar will lose ground.