Canadian Dollar Forecast: Geopolitics and Bank of Canada to Establish the Tone for USD/CAD

USD/CAD has been on a roller coaster ride in recent days amid heightened geopolitical tensions in Eastern Europe after Russia initiated a military operation and began an unjustified invasion of Ukraine. Before dropping to 1.2735 on Friday, the pair briefly rose to a two-month high of 1.2877 on Thursday.

Although oil prices have surged this year, with the West Texas Intermediate blend up 5 percent in February and up over 22 percent in 2022, the Canadian dollar (loonie) has been unable to take advantage of the situation, as high volatility and risk-averse sentiment have limited the appeal of high-beta currencies while boosting demand for safe-haven assets.

The tension between Russia and Ukraine could, however, diminish in the coming days, changing the scenario. We can't predict how this situation will play out, but Moscow's willingness to resume negotiations with Ukraine's leadership on Friday was an indication that diplomacy still has a chance. The Canadian dollar is well-positioned to gain strength in the near term if hostilities cease, thanks in part to better terms of trade as a result of rising commodity prices.

At the same time, Bank of Canada could drive USD/CAD’s reversal lower in the days ahead if it delivers a hawkish interest rate hike on Wednesday when its March monetary policy meeting concludes. That so, the bank is anticipated to boost borrowing costs by 25 basis points to 0.50 percent to confront red-hot inflation, which touched a three-decade high of 5.1 percent y/y in January, more than twice above the 2 percent mid-point target. Because the change has already been discounted to zero, traders should concentrate on the statement's phrasing and forward direction.

With overall economic slack absorbed in Canada, solid employment growth and growing price pressures, BoC could signal that the tightening cycle will be forceful, paving the scene for numerous hikes in the coming quarters. Investors currently expect four hikes in interest rates in 2022, but if policymakers take a harsher posture amid rising inflation threats, the normalization path might reprice higher. The CAD is likely to rise in response to this scenario.

USD/CAD Technical Analysis

If USD/CAD continues its downward trend and breaks below support near the psychological level of 1.2700, sellers may be emboldened to drive the exchange currency towards 1.2600, the 38.2% Fibonacci retracement of last year's June/December rise.

On the flip side, if bulls return and regain control of the market, resistance resides at 1.2878, Thursday’s swing high. If prices go higher and overtake this barrier, bullish impetus might grow, opening the way for a retest of 2021’s high.

USD/CAD Technical Chart