The GBP/CAD exchange rate is currently at 1.6483 having staged a strong start to the new month, and the outlook for the short-term is constructive.

The strength of the move on February 1 is significant from a technical perspective as the GBP/CAD exchange rate's chart is showing a bullish flag shaped pattern which forecasts substantially higher rates.

Flags are chart patterns which consist of a sideways consolidation range which resembles the flag and a steep up-move prior to the flag which resembles the flag’s ‘pole’:

Flags are strong bullish continuation patterns, but the bullish outlook is doubled due to the breakaway gap on Wednesday.

This type of gap often signals a breakout from a consolidation range or chart pattern. They forecast a strong continuation in that direction.

A further bullish sign is the MACD indicator which has crept above the zero-line signalling the possibility of the start of an uptrend.

Despite all the bullish signs we could still like to see a move above the previous 1.6631 highs for confirmation that the uptrend was continuing.

Such a break would probably see the flag extend to its target at 1.7100, calculated by extrapolating the length of the pole higher, from the point of the breakout.

Canadian Dollar Faces a Tough Year

For Morgan Stanley’s chief FX Strategist, Hans Redeker, the CAD is currently overvalued in that it is not fully reflecting the potential for lower interest rates at the Bank of Canada (BoC).

“The CAD rates market has adjusted following last week's BoC meeting, but it is still pricing too hawkish a path given the BoC outlook and rhetoric,” says the Morgan Stanley strategist.

Commercial debt markets failed to adequately price in a pessimistic statement from the BOC in January which said it had not materially changed its outlook since its October meeting.

Morgan Stanley argue investors are overly optimistic on the outlook for the Canadian economy owing to expectations that Canada will benefit from a spill-over from US growth.

“We think trading CAD like a mini-USD doesn't make sense now because Canada's economy has not been improving in line with that of the US,” says Redeker.

There is also the risk that Trump's stance on trade could in fact hurt Canada. BoC Governor Poloz said that the BoC had not modelled the impact of US trade protectionism despite the fact that the BoC was “particularly concerned” about it.

“Canada is right to worry about unintentional consequences of NAFTA negotiation on its economy, particularly with its reliance on export growth to lead the non-oil sector,” remarks Redeker.

But for Redeker, it is a ‘Border Tax Adjustment’ should be of greater concern to CAD.

“Canada should worry also – and possibly more – about is border adjustment; given that the 20% proposed rate from House Republicans would impact all countries equally, Canada (as a major US trading partner) is likely to be heavily impacted,” says Redeker.

The 20% rise in the CAD/MXN exchange rate is an expression of the under-pricing of risk to the Canadian economy from a trade war.

“CAD/MXN shows how little the market is priced for such a scenario, up almost 20% since the election as the market has priced targeted protectionist measures against Mexico but not against Canada.

“People may forget that Canada is essentially as reliant on its trade relationship with the US as Mexico. Even though border adjustment isn't our base case, we still think CAD is not pricing in any probability of it happening,” said Redeker.