Who’s afraid of the big, bad Fed? 17Mar15


Who’s afraid of the big, bad Fed?

Michael O’Neill

FX Consultant / IFXA Ltd

Canada

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  • FX trading rangebound ahead of FOMC
  • EURUSD has a lot further to fall
  • WTI and loonie at odds.

Thank the stars (and the Irish) for St. Patrick’s Day falling on the day before the Federal Open Market Committee meeting. Instead of sitting around at their desks rehashing all the permutations of tomorrow’s statement, traders can do all their rehashing while standing around in a pub, quaffing pints of their favourite Irish grog.

Why worry about FOMC?

There appears to be a lot of hand-wringing and nervousness surrounding tomorrow’s FOMC meeting. Very few people are denying that US rates are going higher – the issue is when? June or September are the two most popular dates, with September being the hands-down favourite.

To quote Alfred E. Neuman, though, “what, me worry?” What difference does a 0.25% increase in rates that are close to zero really mean? It is hard to believe that consumers will stop buying cars, houses and Apple watches because of a ¼ point rate hike. Are global investors really waiting for a ¼ point hike to start a rush to buy US assets?

The real risk from a US rate hike is not just the timing of the next hike, but the introduction of two-way risk. Raising rates by a quarter point gives the Fed room to cut them as well while avoiding the stigma of negative rates. If inflation doesn’t start to climb, a rate cut is a real possibility.

EURUSD: why stop at par?

EURUSD has shed nearly 13% year to date and almost 26% in the past year as the European Central Bank copes with deflation risks and a persistent uneven recovery from the 2008 financial debacle. There is a lot of chatter suggesting that the EURUSD plunge is overdone. A recent report by JPMorgan suggests that the Fed needs to hike rates to 3.5% to justify the current USD valuations.

Undeniably, with short EURUSD positions at record levels, EURUSD is vulnerable to a nasty correction. At the same time, there are many traders waiting (and hoping) for just such a correction to either add to or establish short EURUSD positions, which would limit upside moves.

The long term Fibonacci retracement levels show that the decisive break below 1.1160 at the beginning of the month now targets a 100% retracement of the entire EURUSD range since 2000. That level is 0.8230.

EURUSD weekly

Source: Saxo Bank

The loonie is not a Cinderella story

Perhaps USDCAD traders all took their young children to see Disney’s Cinderella this weekend or perhaps they started celebrating St. Patrick’s Day early. Whatever the reason, they are either in a fantasy world or have been over-served.

A select group of high-level USDCAD traders convene at an important

international summit in Dublin. Photo: iStock

WTI oil is punching through levels not seen since 2009 and the loonie is not reacting. In fact, even as WTI leaked below previous support in the $44.20- $43.60/barrel area, USDCAD drifted lower. Something is out of whack here. It is a safe bet to assume that WTI will not rally because USDCAD is weakening, but the reverse holds true as well.

The outlook for WTI is bearish. The International Energy Association seemingly changed their views about the state of US oil production in their March report:

“Behind the façade of stability, the rebalancing triggered by the price collapse has yet to run its course, and it might be overly optimistic to expect it to proceed smoothly. Steep drops in the US rig count have been a key driver of the price rebound. Yet US supply so far shows precious little sign of slowing down. Quite to the contrary, it continues to defy expectations. Output estimates for Q4’14 North American supply have been revised upwards by a steep 300,000 b/d. The projection of Q1’15 supply has also been raised”.

At the same time a Wall Street Journal story today predicts another flood of oil supplies if the West eases sanctions on Iran on the back of a nuclear deal. Goldman Sachs is also looking for lower oil prices (in the $32.00/b range) as US inventories continue to build. The following weekly chart clearly shows the source of the $32.00/b forecasts. It is the next level of support below the $42.60-$43.00/b area

Chart WTI Weekly

Source: Saxo Bank

USDCAD and oil: modest de-coupling doomed to failure

The following charts shows that the USDCAD rally has not kept pace with WTI oil price declines. Oil prices are making new lows while USDCAD is modestly off its recent peak of 1.2820. The rising risks of another Bank of Canada rate cut on falling oil prices combined with contrasting economic growth prospects between Canada and the US point to further USDCAD gains.

Hourly USDCAD and WTI oil

Source: Saxo Bank

— Edited by Michael McKenna

Categories FX, Foreign Exchange, Currency, Canadian Dollar

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