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Summary: Canadian September CPI saw a slight year-on-year decrease to 3.8%, down from 4.0% in August. On a month-on-month basis, prices fell by 0.1%, in line with expectations.

Fundamentals

In September, the Canadian Consumer Price Index (CPI) experienced a larger decline than expected. The year-on-year inflation rate dropped to 3.8%, below the anticipated 4.0% and down from the 4.0% seen in August.

Gasoline prices, influenced by base year effects, increased by 7.5% year-on-year, compared to a 0.8% increase in August. However, when excluding gasoline, the year-on-year CPI growth rate slowed from the previous month's 4.1% to 3.7%.

On a monthly basis, the CPI declined by 0.1%, contradicting the expected 0.1% increase. This decline was significantly impacted by a monthly drop of 1.3% in gasoline prices, contributing to the economic slowdown.

In the core inflation indicators closely monitored by the Bank of Canada, all three metrics – CPI-Median, CPI-Common, and CPI-Trim – fell short of expectations. CPI-Median dropped from 4.1% year-on-year to 3.8%, while the expectation was 4.0%. CPI-Common decreased from 3.9% year-on-year to 3.7%, falling short of the expected 3.8%. Similarly, CPI-Trim declined from 4.8% year-on-year to 4.4%, weakening the anticipated 4.7%.

In terms of the market, the September inflation report in Canada marks another small step in the battle against inflation, especially as core inflation indicators have cooled off after several months of heating up. On a three-month annualized basis, the CPI-trim and median core measures average fell from 4.3% to 3.7%.

Now, the market has significantly reduced its pricing of the possibility of a rate hike in the upcoming central bank meeting next week. Both 2-year and 10-year bond yields have decreased by 8 basis points and 4 basis points, respectively. With this inflation data, the Bank of Canada now has more relevant data at its disposal before making policy decisions next week. Besides other measures indicating a cooling Canadian economy, there is sufficient evidence to suggest that the Bank of Canada will adopt a wait-and-see approach, keeping the policy rate at 5.00%.

Technical Analysis

On Friday, the USDCAD pair faced pressure and continued to decline ahead of the New York session. Weak inflation data released on Tuesday forced investors to reduce their bets on the Bank of Canada raising interest rates again, keeping the Canadian dollar under pressure. This has overshadowed the generally positive tone in crude oil prices.

From a technical perspective, the overnight consolidation near multi-month highs and trading above the 1.3700 level is seen as a new trigger for bullish trading. Furthermore, oscillators in the daily chart have been gaining positive traction and are far from the overbought zone. This suggests that the path of least resistance for the USDCAD is to the upside.

Therefore, the likelihood of a retest of the recent high of 1.3787 seems significant. Some follow-up buying beyond the psychological level of 1.3800 would bring more bulls challenging the year-to-date peak, near the 1.3860 area reached on March 10.

On the other hand, the 1.3700 level now appears to directly protect the downside for the exchange rate. Any further declines are more likely to attract new buyers around the 1.3655-1.3650 area. This, in turn, should help limit further losses for the bears as they approach the 1.3600 level. If the bears decisively break through that level, the bias may shift in favor of bearish trades.

Overall, considering the recent risk still tilts towards the upside, the USDCAD seems poised to retest the recent six-month highs. However, it's essential to emphasize that this asset has been consolidating at elevated levels for an extended period. Despite the persistent bullish momentum, according to the theory of momentum divergence, a further upward movement for this asset may not be sustainable. In terms of trading, a focus on going short at highs is recommended.

Trading Recommendations

Trading Direction: Short

Entry Price: 1.3700

Target Price: 1.3306

Stop Loss: 1.3795

Valid Until: 2023-11-03 23:55:00

Support: 1.3596, 1.3566, 1.3456

Resistance: 1.3740, 1.3787, 1.3808