CAD/JPY could stage breakout on hawkish BoC

Earlier I wrote on the U.S. dollar/Japanese yen (USD/JPY) currency pair, highlighting a potential breakout in that pair above a long-term bearish trend line. In fact, weakness in the yen is a dominant theme as the ongoing stock market rally continues to undermine the appeal of the safe haven currency. One interesting yen pair to watch this week could actually be the Canadian dollar/Japanese yen (CAD/JPY), due to the Bank of Canada’s rate decision tomorrow.

As my colleague Matt Weller has pointed out in his Bank of Canada preview, the central bank has already raised interest rates three times since the start of last July, and another hike is 80% likely at this meeting. Indeed, the Canadian economy is ticking along nicely with GDP running at a rate of 1.3% y/y and inflation holding above the central bank’s 2% target for the last four months. What’s more, employment rebounded last month as jobs rose by almost 32K on the month, which was better than expected. Furthermore, crude oil, which is Canada’s most important export, have been on the rise of late with a barrel of WTI hitting $75.00. 

So, the stage looks set for a rate increase, but this outcome is mostly priced in. Thus, what the CAD does in the aftermath of the rate decision tomorrow may depend on the signals the BOC will probably give about the next rate increase. At the moment, the chances of another rate increase in 2018 is about 50%, but if that increases after tomorrow’s likely rate increase then so too should the Canadian dollar in value. However, if the BOC turns out to be more dovish than expected then the CAD could drop – especially if it refuses to hike tomorrow. 

But overall we are bullish on the CAD/JPY from a fundamental point of view given the growing disparity between Canada and Japan’s monetary policy stances. Thus, the CAD/JPY may be a good pair to watch for potential strength in the coming weeks and months. 

From a technical perspective, the CAD/JPY has formed a false break reversal when it wouldn’t hold below the prior short-term swing low at 83.15 at the end of June. Its refusal to go lower was rewarded with a quick rally back above this level as the shorts probably abandoned their positions. That rebound may have created a higher low – but we can’t confirm as price is yet to make a distinct higher high.

At the time of writing, the CAD/JPY was approaching a bearish trend line which has been in place from earlier in the year. Judging by the recent bullish price action, a breakout could be on the cards. The trend line comes in around the 85.00 handle with intermediate resistance (old support) coming in at 84.80. Meanwhile, short-term support is now seen at 84.40, below which there’s not much further support seen until that 83.15 level. But for as long as rates hold above 83.15, any interim pullback would not completely invalidate this bullish outlook.