A loonie fairy tale: neither hot nor cold but just right 9Mar16


A loonie fairy tale: neither hot nor cold but just right

Michael O’Neill

FX Consultant / IFXA Ltd

Canada

  • Don’t expect much from the Bank of Canada today – it won’t cut rates
  • The bigger risk is what the ECB announces and its impact on EURUSD
  • USDCAD consolidation set to continue and remain in a 1.3250-1.3450 range.

By Michael O’Neill

A narrowing of China’s trade surplus was all it took to spook traders desperately seeking guidance from central banks. While on that theme, there is a lot of skepticism that European Central Bank president Mario Draghi can deliver on what traders believe is his promise of additional meaningful stimulus today.

Speaking of guidance from central bankers, the Bank of England’s, Mark Carney is warning of Brexit risks. His remarks should be taken seriously because ever since he went on about climate change in September, the weather here in Canada has gone from cold to warm. The evidence is undeniable.

Once upon a time in Canada

“Once upon a time” is the classic opening phrase of many fairy tales and it is an appropriate opening line for the Canadian dollar story so far in 2016.

Once upon a time the Canadian dollar was in a dive, driven by China, oil, the Federal Reserve Bank and weak domestic data. And then, with just a mere sprinkling of pixie dust by the Bank of Canada governor Stephen Poloz, the dive became a rally and the Canadian dollar soared.

Many modern fairy tales have been Disney-fied; re-written with happy endings while the original version endings were a tad less cheery. Little Red Riding Hood, eaten by a wolf, stayed eaten and the Little Mermaid turned to sea foam.

Which way will USDCAD go? Back to the woods or somewhere in between? Photo: iStock

What story will Poloz be reading today? The Disney version or the Brothers Grimm tale?

The Disney version will read something like this: The Bank of Canada is maintaining its target overnight rate at ½ per cent. Inflation is evolving as expected and expansion in the US is on track.

Prices for oil and other commodities have risen which has provided support for the Canadian economy. Federal government stimulus programs which will be announced on March 22 will put the economy on track for a return to above-potential growth.

The Brothers Grimm version will be very similar except it will come with a warning that the large gains in the CAD since the last meeting have the potential to delay the economy’s return to above-potential growth.

The Disney version will lead to further USDCAD losses and a move toward 1.3000 while the Brothers Grimm version may lead to 1.3250-1.3500 consolidation at least until after the March 22 budget.

USDCAD pros and cons

The pros

  • Oil price stability. The rebound in WTI prices from the $26.10 low has WTI in a steady uptrend, supported by the break of the long term downtrend from June 2015.
  • Neutral Bank of Canada: The BoC is reluctant to cut interest rates and appears to view the recent market turmoil sparked by China and falling oil prices as just a temporary distraction
  • Rising commodity prices: The Bank of Canada Commodity Price Index (BCPI) is almost back to where it was on January 1, 2013. The difference today is that it is on an uptrend and not a downtrend.

Bloomberg Commodity Price Index

Source: Bloomberg

  • Federal government fiscal stimulus: On March 22, the Federal government will announce $10 billion in stimulus spending programs which are expected to jump start the economy.
  • Strong domestic data: Recent Canadian economic releases surprised to the upside with additional positive sentiment derived from the bump in December GDP.
  • Rebounding US economy: The US data has been mixed to strong providing further evidence that the economy is growing. A healthy US economy is always beneficial to Canada and the Canadian dollar since the US is the destination for over 75% of Canadian exports.
  • CAD demand: This stemming from the selling of GBPCAD on Brexit concerns and sales of EURCAD due to diverging Eurozone and US economic growth trajectories as well as widening interest rate differentials

The cons

  • The USDCAD correction from the January peak may be overdone. The presence of support in the 1.3200-50 area as a result of multiple tops and bottoms in 2015 may limit USDCAD losses. Also, the 200 day moving average is significant in that USDCAD has rarely spent much time below that area since 2013.
  • US interest rates are still likely to rise while Canadian rates are still more vulnerable to a rate cut than a hike.
  • Oil prices have rebounded strongly, however the sustainability of the gains is questionable considering that Iran is not part of the production cap agreement and Kuwait says that they won’t participate unless everyone does. US crude stocks inventories remain at elevated levels.
  • China news and policies are still disrupting markets. The drop in the trade surplus announced overnight undercut global equity indices. In addition, most analysts still believe that China will continue to devalue their currency.

USDCAD technical outlook

Intraday: The intraday technicals are bullish while trading above 1.3305 looking for a break of resistance in the 1.3370-80 area to extend gains to 1.3405. A move below 1.3310 targets a retest of Monday’s low.

Short term: The downtrend line following the break of support at 1.3650 remains intact while trading below 1.3410, looking for a break of support in the 1.3220-80 zone to extend losses to 1.3000.

USDCAD hourly chart

Source: Saxo Bank

Long term: The long-term uptrend line remains intact above 1.3120 which is being guarded by multi-bottom support in the 1.3200-50 area and the 200 day moving average at 1.3291. Fibonacci retracement of the 2015-2016 range warns that a move below the 50% level of 1.3145 would target the 61.8% level of 1.2778

USDCAD daily chart with Fibonacci

Source: Saxo Bank

A penny’s worth of thoughts

Don’t expect much from the Bank of Canada today. They will not be holding a press conference after the rate decision is announced. Since they have already said that they will want to see the details of the Federal stimulus package, the statement will likely be blander than normal and therefore a non-event.

The bigger risk is what the European Central Bank announces and its impact on EURUSD. Then there’s next week’s Federal Open Market Committee meeting. Because of that, USDCAD is likely to remain in a 1.3250-1.3450 range.

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Author: Loonieviews

In the past 30+ years, I have been an FX interbank market making trader, a high performing FX and Derivatives Sales person, creator of simple and complex risk mitigation strategies and a manager of high performance FX teams. The Trade of the Day is a culmination of that experience. Retail FX traders have access to a well-crafted and carefully researched FX trade strategy designed to generate FX profits while mitigating losses.

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