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Article / 27 September 2013 at 5:44 GMT

The chronicles of contrarian

FX Trade Strategist / www.Loonieviews.net
Canada

USDCAD traders are in denial. FX traders were long USDCAD going into last Wednesday's Federal Open Market Committee (FOMC) meeting fully expecting the participants to follow through on their guidance and announce a tapering program.  The major unknown was thought to be the size of the taper. Would it be five, 10 or even 15 billion US dollars a month? Surprise! The FOMC decided to maintain the status quo which sent the USDCAD plunging, eradicating support congestion in the 1.0240-80 area and even taking out the 200-day moving average at 1.0210 before coming to a halt at 1.0184.

That move made sense. The USDCAD market was thought to be very long dollars and stop loss selling would have exaggerated the downward move. The FOMC decision to continue printing money in part due to "headwinds" affecting US economic growth is a bearish US dollar sentiment by itself. The elevation of Janet Yellen to Fed Chairwoman-in-waiting (a widely-held perception) added to the negative dollar outlook.

Bouncing off the bottom
The USDCAD bounced off the bottom rather aggressively. Within 24 hours of dealing at 1.0184, the USDCAD rate had recouped all its post-FOMC losses and until yesterday's 11:00 am fixing rate (15:00 GMT) had traded in a narrow 1.0270-1.0320 band. The only other currency pair to retrace all of its gains was AUDUSD. The other majors either kept most of the upside (like EURUSD) or at least half of the rally (GBPUSD). The AUDUSD weakness may be explained in part by bearish technicals with the currency pair flirting with the 0.9275-0.9335 support zone and by a new government that ostensibly wants a weaker currency to deal with the soft mining outlook.

The Loonie on the defensive
The Canadian dollar's retreat back through what previously were key support levels may be a factor of the triple whammy of quarter end, month end and Japanese year end flows that created a demand for USDCAD.  CADJPY has been on a downtrend after peaking post-FOMC at 97.45 which may be because of repatriation flows. The risk of a US government shutdown on September 30, may have given rise to some risk aversion trading and USDCAD demand. EURCAD and GBPCAD have both moved higher adding to the Canadian dollar woes. Other rationale for buying USDCAD includes a mixed economic growth outlook, weaker commodity prices and the fact that tapering has only been delayed not cancelled.

The contrarian chronicles
The USDCAD rate is merely consolidating its post-FOMC gains and is only trading near the top of the range due to quarter end flows with a dollop of risk aversion over US political posturing thrown into the mix. Below are three reasons why the USDCAD is likely to resume its downtrend next week as the previously mention influences fade from memory.

1)  US and Canada 10 year rate spreads are basically unchanged pre- and post-FOMC.  The 10-year US Treasury note which yielded 2.87 percent pre-FOMC and is now 2.66 percent. The equivalent 10-year Government of Canada bond yielded 2.77 percent pre-FOMC and is now 2.59 percent. The US does not benefit from any real yield advantage.

2)  The post-FOMC break of multiple USDCAD supports including the July lows, Fibonacci retracements from September 2012 and May 2013 and the 200-day moving average all support the view that the US dollar bounce from the lows is just a correction, albeit a fairly aggressive one. The US dollar downtrend from the 1.0558 September peak comes into play at 1.0340.  Furthermore, the 100-day moving average is at 1.0355 and the 38.2 percent Fibonacci retracement of the September move is at 1.0324.

USDCAD Daiy chart with Fibonnaci and 100-day moving average

usdcad

Source: Saxo Bank

3) The USDCAD and the US dollar index (USDX) have diverged recently.  The USDX has been in a downtrend since peaking at 84.93 in July and broke through major support at 80.65 following the FOMC decision and hasn't been able to get back above that level which indicates further US dollar weakness ahead. Meanwhile, USDCAD has tracked the USDX fairly religiously but appears to have deviated in the past few days.  I would argue that since the short-term outlook for the USDX is bearish, the USDCAD is likely to fall back into line, meaning a lower US dollar.

USDX and USDCAD showing deviation

usdcad

Source: Saxo Bank

 

Conclusion
The USDCAD is only bid due to September quarter end, month end and Japanese year end flows. The recent bounce to test the top of the downtrend line is merely a corrective move due to the eradication of a long-term USDCAD congested support area and the bearish USDX technicals. 

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