Loonieviews October 20, 2014

More turbulence ahead for FX markets

Michael O’Neill

FX Consultant / IFXA Ltd



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  • Volatility is back on global slowdown fears
  • Bank of Canada MPR won’t offer any surprises
  • USDCAD sentiment is bullish

By Michael O’Neill

The week has barely started and FX markets are already jittery. The US dollar traded a tad softer overnight, giving up ground against the G7 currencies as traders reassessed last week’s fears that US economy was on the verge of derailment.

Over the weekend, Federal Reserve Bank of Boston president Eric Rosengren said that the Fed shouldn’t react to the recent turmoil as "volatility is just a reflection that there is a lot of uncertainty in the market". Strong US home sales data could help to take the sting out of the "slowing economy" theme.

Unhappy with FX volatility? Get used to it

Volatility has reared its head on a re-evaluation of global macroeconomic issues, but geopolitical risks still appear to be somewhat "off the radar". To us, this suggests more volatility surprises ahead. The price action last Wednesday and Thursday was a rude awakening for traders who had grown complacent over the past months.

Historically, volatility triggers might have included: a near-war between Russia, Ukraine and NATO; rising tensions between China and its Gulf of China neighbors; Sabre-rattling between China and Japan over uninhabited rocks; the rise of ISIS and the approach of civil war in Iraq; and Iran’s nuclear ambitions, to name but a few. Yet these events are still viewed as a sideshow to the global economic outlook.

Pictured: the sort of thing that very much remains a factor. Photo: iStock

In a very timely speech on October 14, Reserve Bank of Australia assistant governor Guy Debelle noted that “there are a number of anomalies present in financial markets in terms of pricing and volatility. There are also some misplaced perceptions amongst market participants about the degree of liquidity present in some market segments. That strikes me as a dangerous combination and unlikely to be resolved smoothly”.

Debelle also pointed out that even though the US dollar has appreciated, on a trade-weighted basis it is still not that far above its all-time lows. He may be on to something.

VIX/CBOE Volatility Index (daily)

Source: Saxo Bank

Plucking the loonie’s feathers

Wednesday’s "no rate change" announcement from the Bank of Canada won’t surprise anyone, but the statement itself could raise a few eyebrows. Anyone expecting a neutral statement with a bite will be disappointed.

Last week’s near-panic after a soft US retail sales report will feed into the BoC’s cautious outlook. It wouldn’t be a stretch for governor Stephen Poloz to marshal US economic slowdown fears in support of the Bank’s lagging export concerns. In light of Thursday’s big drop in manufacturing shipments for August, in fact, this could prove quite likely.

Unlike the Reserve Bank of New Zealand’s Graeme Wheeler, however, Poloz is unlikely to pen an essay on the unjustifiable heights of the loonie. When the Kiwi fell upon the release of Wheeler’s statement, however, the Canadian dollar quickly became collateral damage.

Birds of a feather fall together. Photo: Purestock

In a world where many G20 nations are both overtly and covertly devaluing their currencies, the Bank of Canada can’t be unhappy with the Canadian dollar’s slide. We expect that the BoC’s statement will make the usual noises about the gradual strengthening of fundamental growth and inflation drivers while highlighting “spare capacity concerns”. Ultimately, the bank will maintain its neutral bias (which the market views as dovish).

MPR a downside-only affair

The quarterly BoC monetary policy report will be overshadowed by global economic development concerns and oil prices. A positive or even modestly positive outlook will barely cause a ripple in USDCAD due to the current divergence of Canadian and US interest rate expectations.

On the other hand, a slightly negative report could really undermine the loonie due to bullish US dollar sentiment.

USDCAD outlook

It is a lousy week for Bank of Canada announcements about interest rates and the MPR as FX traders are fixated on global economic developments and oil prices. The BoC news may be important for domestic consumption, but US dollar trends versus the majors will govern USDCAD trading.

At the same time, the FX market appears negatively biased toward the Canadian dollar and is positioned that way. Unexpected positive surprises to retail sales or Consumer Price Index data could fuel a sharp USDCAD plunge.

USDCAD technical outlook

The outlook for USDCAD is bullish while trading above 1.1000 in the short term and above 1.0780 in the medium term. The intraday technicals are modestly bearish while trading below 1.1280 but need to break through support in the 1.1210-20 area to extend losses to the 1.1150-70 zone. A move above resistance at 1.1280-90 targets 1.1380 and then 1.1500.

USDCAD four-hour

Source: Saxo Bank

Key US data releases

  • Tuesday: September Existing Home Sales (Forecast 5.09 million). This usually minor release may have an elevated impact due to its potential to alleviate some of the fears that the US economy is going off the rails.
  • Wednesday: September Consumer Price Index (Forecast 1.7%, 1.7%, year over year) A consensus or lower CPI will provide a modicum of support for those looking for the Federal Open Market Committee to maintain a dovish bias.
  • Thursday: Conference Board September Leading Indicators (Forecast 0.7% vs August 0.2%) Another minor data tidbit that could support US dollar bulls if it surpasses the forecast.
  • Friday: September New Home Sales (475,000)- same implication as Monday’s data.

Key Canadian data releases

  • Wednesday: August Retail Sales (Forecast negative 0.1%, ex-autos, negative 0.3%, month over month) A below consensus result will fuel Canadian dollar negativity while a better than expected print would drive USDCAD back to the 1.120020 support area.
  • Wednesday: Bank of Canada Interest Rate announcement, Statement, Monetary Policy Report and press conference.
Categories FX, Foreign Exchange, Currency, Canadian Dollar

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