Voodoo science and a Loonie scenario
FX Consultant / IFXA Ltd
- US dollar remains in demand ahead of FOMC
- Canada employment data weak
- Beware the Ides of March (just because)
By Michael O’Neill
Friday the 13th has proven to be bad news for USDCAD bears as even a better-than-expected Canadian employment report wasn’t able to offset the drag from the steroid pumped US dollar.
Admittedly, the Canadian employment data was far from stellar, it was just not as ugly as expected and gave no reason to buy the Loonie.
The looming shadow of the Federal Open Market Committee statement on Wednesday may confine trading in the majors to existing ranges as it should be difficult to find anyone who doesn’t believe that the loss of "patience" isn’t already priced in.
The tea leaf analysis – a USDCAD scenario
There is no denying that USDCAD is in an uptrend. The reasons for the rally are well known but a quick recap is in order.
1) Sharp plunge in oil prices with an ongoing bearish bias.
2) Widening of Canada and US interest rate differentials. Canada cut rates by 0.25% on January 21 and although the Bank of Canada professes to be “neutral”, the market is leery of another cut in April.
3) US interest rates are headed higher with the FOMC expected to signal a June or September hike with the removal of the word “patience” in the March 18 statement.
4) Ongoing US dollar strength against the majors on diverging economic growth prospects and interest rate trajectories.
Voodoo Science (but food for thought)
The following chart shows that USDCAD has declined beginning around the end of March until the July-August period, in eight of the past 10 years with 2008 and 2012 being the exceptions. The same sort of move could happen this year.
USDCAD 10-year daily with March declines shown
Source: Saxo Bank
Mind the gap
The USDCAD (and the rest of the G-10) rally that began in January has been relentless and steep. Short- and medium-term trend lines are well below current spot levels, suggesting corrections could be sharp and just as steep, while keeping the dominant US dollar uptrend in place. The following chart highlights that even a minor correction could see USDCAD fall from its current price (1.2725) to 1.2250 while a major correction could see a plunge to 1.1750.
USDCAD daily with correction levels shown
Source: Saxo Bank
In my opinion, the most obvious catalyst for a US dollar sell-off is the market’s reaction to the FOMC statement on March 18. The omission of “patience” from the statement (which is widely anticipated) is seen by many as the harbinger of a June rate hike. FX markets are notorious for “selling the rumor, buying the fact” or vice versa.
If the Fed delivers on expectations while hinting that a rate hike may not be as imminent as predicted, the USD could retreat. From a global perspective, the fact that all the G-7 countries have eased rates this year in addition to China and India, is in effect a defacto US rate hike. Maybe the FOMC members see it that way as well.
A US dollar drop may also boost oil prices, fueling additional demand for Canadian dollars. The sheer size of outstanding speculative positions in the majors could turn a minor profit taking rally into a rout.
The point is that USDCAD is approaching significant resistance in the 1.3000-50 area. That zone has represented strong resistance on rallies and support on reversals over the past 15 years and there is no reason to expect a different outcome this time around.
There could be a rout after the FOMC statement next week. Photo: iStock.
The week that was
This week’s lack of quality risk and US data events didn’t deter the volatility gremlins which made for another entertaining thrill ride on the FX
The US dollar was bid from the get-go on Monday. There wasn’t any particular reason offered other than “more buyers than sellers”. Chatter about the size of the ECB bond purchases and numerous headlines about Greece ahead of a Eurogroup meeting provided distractions but had little real FX impact.
Tuesday, EURUSD traders in Asia were singing
Wednesday, the bottom fell out of EURUSD, sparking a widespread US dollar rally across the G-10 and Emerging Markets and once again, there wasn’t any specific catalyst for the move. A spate of weak economic reports opened the door for additional easing in China. Mario Draghi spoke at the Eurogroup conference but didn’t add anything new.
Greece debt renegotiation demands were reportedly not well received. The New York day ended with news that the Reserve Bank of New Zealand left rates unchanged. The ensuing Kiwi rally may have also set the tone for Thursday’s session.
As is becoming the norm of late, Thursday was turbulent. It started in Asia. The NZDUSD rally was infectious, spreading to AUDUSD and USDJPY. The USDX, which had a peak above 100 was swatted down to 99.00. EURUSD clawed back Wednesday’s losses in an orderly rally from 1.0495 to 1.0642 before drifting lower. As was the case for most of the week, the moves were more a function of herd mentality and profit preservation rather than specific drivers.
The week that will be
It is said that there is no rest for the wicked but if next week’s events live up to expectations, you could replace wicked with FX traders.
Monday may get off to a slow start due to a lack of top tier data, but Tuesday should more than make up for it. The Reserve Bank of Australia minutes and the Bank of Japan interest rate statement and press conference may cause a stir during the Asian session while Eurozone CPI and the German ZEW survey makes life interesting in Europe. That is, of course, if St Patrick’s Day parties don’t get in the way.
Wednesday will be as dull as dishwater until the late New York afternoon when the FOMC statement is released. Patience may be a virtue but losing patience may be vicious. The fall-out from this statement will dictate FX trading for the rest of the week.
– Edited by Oliver Morrison