Rue Britannia

FX Consultant / IFXA Ltd

Canada

· Month-end mayhem may have already begun

· Oil and loonie rangebound together

· US data disappoints-again

By Michael O’Neill

It has only been five days since UK voters rejected prime minister David Cameron and his enthusiastic support for the European Union. Brexit supporters, led by Boris Johnson, are euphoric. The rest of the world? Perhaps not so much.

The collapse of GBPUSD on a Leave win was not unexpected but the magnitude of the plunge (nearly 0.1900 points or 12.6%) caught more than a few players flat-footed. And the effects of the decision have spread like the plague across the globe.

Cameron’s decision to allow a referendum on EU membership was reportedly a vanity ploy and meant to shore up his position within his own party. It didn’t work. UK voters have chosen to leave the largest economy in the world to go it alone in an environment where new trading blocs are emerging, not disintegrating. The TransPacific Partnership is one such bloc, consisting of 12 Pacific Rim nations including Canada, USA, Japan, Australia and New Zealand.

Cameron has handed in his notice but he still has his hands on the reins of power, theoretically allowing him to make more bone-headed decisions. Where is the monarchy when you need it? Wasn’t the Tower of London built to deal with these kinds of miscreants?

From Downing Street to down in here. Photo: iStock

US dollar holds (most) of its gains

FX markets have yet to recover. The US dollar has managed to keep a healthy chunk of the post-Brexit gains as markets and policymakers attempt to determine the ramifications for the global economy.

Currency gain/loss versus G10 (June 23 at 2200 GMT to June 28 at 1430 GMT):

Source: IFXA/Saxo Bank

Cautious Fed even more cautious

Federal Reserve chair Janet Yellen is a cautious lady. She said that it was appropriate to “proceed cautiously” in her speech to the New York Economic club at the end of May. She said it again in her testimony to the Senate banking committee last week. The Brexit vote validated her concerns.

The US interest rate hike was expected in June, in part because that is what numerous Fed speakers told markets would happen. It failed to materialise. That was because of Brexit uncertainty. There is no longer any uncertainty about the Brexit, however – it happened. Now, the uncertainty is not “when will the Fed hike interest rates again in 2016" but "will the Fed hike rates in 2016”?

There is even a faction that believes the Fed could cut rates.

CME FedWatch Tool:

Source: CME Group

More drama ahead

The FX volatility of the past few days isn’t going away any time soon. In addition to the looming risk of renewed GBPUSD weakness, FX traders have to deal with month-end, quarter-end, and half-year end portfolio rebalancing flows today through Thursday which may lead to US dollar selling.

Those flows, as much as anything else, may have contributed to today’s mild “risk-on” environment.

USDCAD rangebound but with a bid

The Canadian dollar, like the Aussie and kiwi, has been tossed about like a small boat in a big sea, while maintaining the integrity of the month-old trading range. Canadian dollar weakness will come from soft commodity prices and risk-aversion trading due to Brexit.

At the same time, the Canadian dollar will benefit from GBPCAD selling in the event of a renewed GBPUSD selloff. In addition, the prospect that the Fed is not just on hold for the balance of the year but may even be considering a rate cut will temper the market’s enthusiasm for dollars.

Could the Brexit story end on a CAD-boosting note? Photo: iStock

Stable oil prices are also keeping USDCAD contained in the range. Oil demand is expected to rebound in Q4 while US crude storage declines. The WTI range of roughly $45-$52/barrel as coincided with the 1.2500-1.3200 range seen in USDCAD for the past month.

Furthermore, if global investors plan to flee the UK/EU turmoil, Canada – with its stable banking system, moderately growing economy, huge natural resources, and status as an equal partner in the North America Free Trade agreement – would look pretty attractive.

USDCAD (four-hour chart):