Dollar Canada closes at seven month low on Friday.
First test of 1.3050, rebounds to finish at 1.3100 resistance/support.
Annualized GDP contracts 38.7% in Q2, less than the -39.6% forecast.
WTI fails at $43.50, minimal damage from Hurricane Laura on the US Gulf Coast.

The Canadian Dollar reached it best level against the greenback since January as the Federal Reserve’s new inflation policy may keep US interest rates at the zero bound indefinitely.

The immediate dollar reaction, as elsewhere, was negative and the USD/CAD shed almost 50 points to 1.3106. A rebound within an hour brought the pair back to 1.3161, above where it had been before the Fed announcement. After two more attempts at 1.3100 reaching a low of 1.3102 the USD/CAD settled to a narrow range just above 1.3120 for the remainder of Thursday’s trading.

Friday’s progressive weakness cracked support at 1.3100 in London and tested 1.3050 touching 1.3047. But with London and New York headed to the weekend the essay was brief and USD/CAD recoiled swiftly to the 1.3100 transformed resistance line which is also coincident with the lower border of the down channel that goes back to the beginning of July.

Hurricane Laura came ashore on the US Gulf Coast as a Category 4 storm but caused little damage to the US oil refining industry. West Texas Intermediate, (WTI) which had crossed $43 for the first time since early March in anticipation reached $43.57 on Tuesday, but by Friday's close had dropped back to $42.97.

Average inflation targeting

Average inflation targeting as the Fed calls its new inflation policy will permit prices to rise above the 2% goal for as long as necessary to balance an earlier period of weak performance.

The immediate implications of the Fed’s new inflation goal are few. Inflation in the bank’s preferred measure, the core PCE gauge, was just 1.3% in July, well below its 1.9% rate in February and far from the 2% target.

But PCE prices have been underperforming for more than a decade. Since the financial crisis only one year, 2018 with an average rate of 1.96%, came close to target. Price gains that year were due more to the excellent economy than any residue from seven years of zero rates or four rounds of quantitative easing.

When the Fed began its quantitative easing experiment in 2008 inflation was the expected result. It did not occur. That lesson was the genesis of the Fed’s policy review.

Inflation averaging and employment

One purpose of the new policy is to eliminate the tight connection between low unemployment and inflation that had traditionally guided Fed policy. The FOMC is now free to focus and provide support for the labor market even if inflation runs above target for a considerable period.

Fed forward guidance has stressed the need for rate and fiscal support for the economy until the US is well clear of the effects of the pandemic closures.

Projection materials

By limiting the inflation trigger this latest policy shift extends zero rates to an indeterminate future. While no duration of the emergency policies has been discussed by Fed officials, the last Projection Materials in June had the fed funds rate unchanged to the end of 2022, the limit of the annual estimates. The final rate projection category, which the Fed calls inclusively ‘longer run’ and can be viewed as the FOMC’s estimate for a normal economy, was 2.5%.

Will the Fed dare to reduce that to 0.1 in the September projections?

Canada and US statistics summary August 24-August 28

It was a sparse summer week in Canada.

Canadian GDP contracted a record 38.7% on an annualized basis in the second quarter slightly less than the -39.6% forecast after an 8.2% drop in the first three months. Monthly GDP rose 6.5% in June and 4.8% in May following the 19.5% decline in March and April.

A busy week in the US. Economic data suggested the recovery is gathering strength but without a breakthrough indicator.

The Richmond Fed manufacturing index jumped to 18 in August from 10 prior. It was the best reading since October 2018. The pandemic low was -54 in April.

New home sales soared 13.9% to an annualized rate of 901,000 in July from 791,000 in June for the highest since the housing bubble in May 2007.

Durable goods rose 11.2% in July, more than double the 4.3% prediction and have gained 36% in the last three months, reversing the 35% decline in March and April. Non-defense capital goods, the business investment proxy, rose 1.9% as expected and the June result was revised to 4.3% from 3.3%. Here also

the 7.8% shutdown decline has been erased by the subsequent 7.8% increase.

Second quarter GDP was revised to -31.7% from -32.95 and the Atlanta Fed GDPNow third quarter estimate climbed to 28.9% from 25.6%.

Jobless claims for the week of August 21 were 1.006 million as forecast and continuing claims registered 14.535 million from 14.758 million the previous week.

Personal income for July gained 0.4%, much better than the 0.2% expected drop and June’s 15 decline. Personal spending rose 1.9% beating the 1.5% estimate, and combined with the May and June readings at 16.6% has made up 85% of the 19.5% March and April decline.

Michigan consumer confidence for August was revised slightly higher to 74.1 from 72.8. The pre-Covid score was 101 in February and the low was 71.8 in April.

The core PCE price index was 1.3% year on year in July a bit higher than the 1.2% estimate and June 1.1% rate. February was 1.9% and March 1.7%.

USD/CAD outlook

Until the US economy provides conclusive proof that the closure collapse in GDP and employment is mending and the danger of a second or third wave of the Covid infection is past the dollar weakness that has ruled since early July will continue.

The Fed’s new inflation goal, while having no impact on current policy adds to the impression of overall decline. In practice it will make no difference.

Interestingly, longer-term US Treasury rates were already higher from their early August lows before the Fed’s announcement. The mention of potentially rising inflation, at whatever distance, has reinforced the notion of economic recovery.

The Treasury market may be indicating a turn in the US outlook is at hand. It bears watching.

Canada statistics August 24-August 28

FXStreet

US statistics August 24-August 28

FXStreet

Canada statistics August 31-September 4

US statistics August 31-September 4

FXStreet

USD/CAD technical outlook

Friday's rebound brought the USD/CAD to the 1.3100 line. Whether that will be support or resistance will be determined in the Monday session.

The two-month old down channel remains the dominant feature. The Friday drop reversed at the 1.3050 support and returned to the bottom limit of the channel. The relative strength index at 32.04 verges on oversold status but that should not prevent another test of support this week. The moving averages are all above with only the 21-day at 1.3247 in current range. The 100-day is at 1.3634 and the 200-day at 1.3527.

Resistance: 1.3100; 1.3160; 1.3225; 1.3320; 1.3400

Support: 1.3100; 1.3050; 1.3000; 1.2950

Average inflation targeting

Inflation averaging and employment

Projection materials

Canada and US statistics summary August 24-August 28

USD/CAD outlook

Canada statistics August 24-August 28

US statistics August 24-August 28

Canada statistics August 31-September 4

US statistics August 31-September 4

USD/CAD technical outlook

USD/CAD sentiment poll

USD/CAD Weekly Forecast: The path of least resistance