USD/CAD sharply higher, eyeing 1.2600, after pair hurdled key resistance at 1.2480

• USD/CAD is trading sharply higher on Thursday and eyeing a test of the 1.2600 level after surging above 1.2480 resistance.
• The pair is seeing some belated outperformance in wake of Wednesday’s hot US CPI report.

USD/CAD is seeing some overdue outperformance on Thursday. In wake of a much stronger than expected US Consumer Price Inflation (CPI) report on Wednesday, the US dollar surged against the majority of its G10 counterparts, but the loonie was largely spared at the time. That’s because, as USD/CAD attempted to push higher, it ran into a wall of resistance around the 1.2480 level in the form of recent highs and its 200-day moving average. In the end, USD/CAD ended the session just 0.4% higher (versus much larger moves in the likes of GBP/USD, EUR/USD and USD/JPY).

As trading volumes picked up during Asia Pacific hours, the pair was finally able to break to the north of the key area of resistance and has subsequently shot above the 1.2500 level, the 50DMA at 1.2535, and is currently closing in on the 1.2600 mark. Oil prices dropped sharply on Wednesday amid fears that higher US inflation would prompt the Biden administration to release crude oil reserves to combat high energy costs. Though prices are a little higher on Thursday, they still remain some way off from recovering back to pre-CPI data levels, thus crude oil weakness is one reason the loonie is dropping sharply on Thursday.

Another reason for loonie underperformance is that, in wake of the US CPI data, the Canadian rate advantage over the US has been slightly eroded (as traders up their bets on a more hawkish Fed in 2022). US 5-year government bond yields saw a 14bps surge to 1.22%, while the Canadian 5-year rose 10bps to and was unable to move back above 1.50%. Government bond and short-term interest rate (STIR) markets still price a much more hawkish BoC when compared to the Fed.

But there is a growing throng of economists/analysts who are starting to believe that this view is wrong. According to CIBC, “markets have overpriced Bank of Canada (BoC) action in 2022, and underestimated the Federal reserve post-2022”. “A recalibration”, continues the bank, “will leave the CAD out of favor with investors”, before concluding “we see USD/CAD drifting above the 1.30-mark next year, as it becomes clear that Canada's central bank will not be outgunning the Fed”.