Canadian dollar outlook: USD/CAD reversal risk grows after steep slide

• USD/CAD breakdown followed late-November reversal signal
• U.S. data resilience reduces odds of January Fed cut
• Canadian inflation softens, crude hit multi-year lows
• Bullish engulfing candle hints at swing bottom

Summary

The bearish unwind in USD/CAD we warned of in late November played out exactly as flagged, delivering a powerful breakdown following an obvious reversal signal on the weeklies. But after such a steep slide, the move now looks stretched. Recent U.S. private-sector data has held up well, limiting the risk of the Fed delivering a fourth consecutive cut in January. At the same time, the latest Canadian inflation report revealed easing price pressures. Throw in crude oil hitting multi-year lows and it takes some of the sting out of the bullish CAD case. Traders should now be alert for signs of a swing bottom, which could mark the start of a corrective bounce.

Shifting Macro Backdrop Questions Bearish Bias

When we turned bearish on USD/CAD at the end of November, the backdrop was clear: Canadian data was perking up, the Bank of Canada (BoC) looked close to calling time on cuts, and Fed easing bets were building fast. Fast forward to now and the tone has shifted. U.S. data has held up better than feared, Canadian inflation has softened, and crude has slumped to multi-month lows. That’s a very different mix to what drove the breakdown.

On the U.S. side, November payrolls rose 64,000 after October’s 105,000 slump tied to federal job losses, but private-sector hiring is the real story. It's averaged 75,000 over the past three months, led by healthcare and construction. And while retail sales were flat in October, the control group that feeds into GDP delivered a chunky gain, pointing to underlying resilience in spending. That combination makes a fourth consecutive Fed cut in January look unlikely.

Canada’s overall data tone has been decent, helped by a big drop in unemployment in November, but the November inflation report released earlier this week told a different story. Headline CPI held at 2.2% from a year earlier, while core slipped below 3% for the first time since March, with the average of the two core measures sliding to 2.8%. Food prices jumped 4.2% over the year, but most other components cooled, with gasoline slumping 7.8% over the same period. That softness gives the BoC time to pause and assess rather than rush into tightening policy, especially with crude hitting multi-month lows.

Put it all together and the backdrop looks less one-sided than it did a few weeks ago. The bearish USD/CAD move was justified, but after such a sharp breakdown, the risk-reward is shifting. With 1.3725 acting as support, traders should be watching for signs of a swing bottom and a corrective bounce rather than chasing fresh lows.

USD/CAD Bottoming?

Source: TradingView

Given the price action on Wednesday, we may have just seen one in the form of a bullish engulfing candle. Coming after a prolonged downturn and a string of doji candles pointing to market indecision, the merits of the signal are arguably strengthened, especially as the reversal came ahead of key support at 1.3725.

With RSI (14) flicking higher from oversold territory and MACD looking like it’s bottoming deep in negative territory, the momentum picture suggests downside strength is waning. While both remain firmly in bearish territory, favouring a similar bias, combined with Wednesday’s price signal, it feels like we may be at or nearing a turning point.

Pullbacks towards 1.3725 would offer an attractive entry level for longs, allowing for a stop to be placed beneath the level for protection against a resumption of the prior bearish trend. Of course, there’s no guarantee we’ll see a pullback given the price signal, meaning those looking to enter around current levels would need to assess what target would be necessary for the trade to stack up from a risk-reward perspective.

Levels to consider include 1.3800 and 1.3825, both of which were tested from either side earlier this month, along with 1.3873 (12 Dec high) and key 200-day moving average. Price action at the latter will be important when it comes to longer-term directional risks, should it get back there.

While it comes with the very big caveat that it's not over, as things stand, the latest candle on the weekly timeframe looks like a hammer in the making, providing another potential bullish reversal signal to complement the one received on the dailies, should it finish around these levels. Watch the close on Friday!