Article / 19 July 2016 at 15:41 GMT

Geography lessons and 'what ifs'

FX Consultant / IFXA Ltd
  • US housing data ticks another box in rate-hike debate
  • Commonwealth currencies under pressure
  • AUD, NZD and CAD sank together though the CAD is not an antipodean currency
  • Soft oil prices weigh on Canadian dollar
  • Hawkish Fed will boost USD; USDCAD will retest resistance at 1.3200

Canada's place in the world
 FX markets seem to be confused about Canada's situation 
on the globe. Image: iStock

By Michael O'Neill

The US dollar got a fairly strong start to the day supported by housing data that flaunts the strength of the US economy in a world where many central banks are contemplating new stimulus measures.The US dollar has gained across the G10 spectrum.

Geography lesson: Canada's dollar is not an antipodean currency 

Some days FX traders need a geography lesson. Today is one of them. In FX markets, the antipodean currencies are the Australian and New Zealand dollars. According to Oxford Dictionaries, antipodean is an “adjective relating to Australia or New Zealand" and a noun used to describe a person from either of those countries. It doesn’t refer to Canada at all.

Except that overnight it did. The Australian dollar, New Zealand dollar and Canadian dollar sank together.

NZDUSD was hammered due to increased speculation of a rate cut in August precipitated by the Reserve Bank of New Zealand’s issuance of a bulletin about financial risks from housing market cycles.

AUDUSD dropped after the Reserve Bank of Australia published the minutes of its July meeting. The minutes didn’t offer any fresh insight but left rate-cut speculation intact.

The rationale for the Canadian dollar's weakness wasn't readily apparent. There isn’t even a whiff of a rate cut in the Canadian air.  Apparently, the CAD sank because of low oil prices. That's a dubious conclusion considering that WTI crude oil prices remained  well within last week’s trading range.

The loonie sank even after the Bank of Canada issued an upbeat third-quarter economic forecast just last week. It fell despite evidence that Canada’s largest trading partner's (USA) economy is rebounding to such an extent that rate hikes are being contemplated. It sank because it is a "Commonwealth" currency.

New Zealand landscape with sheep
 Make no mistake, these fine New Zealand sheep would get very tired 
swimming all the way to China. Photo: iStock

Canada, Australia and New Zealand share a lot of similarities. They all speak English (sort of), they are members of the Commonwealth of Nations, and they have images of Queen Elizabeth ll on their money.

The biggest difference is geography. Ninety percent of all Canadians live within 160 kilometres (99 miles) of the US border, the largest economy on the planet (in terms of nominal GDP). It is a short drive. One hundred and sixty kilometres from the Australian or New Zealand borders is nothing but shark-infested salt water.

One of Canada’s major exports to the US is energy. It is far easier to build a crude oil or natural gas pipeline to the USA then it is for Australia to pump iron ore 7,470 plus miles to China. New Zealand doesn’t fare any better. Canadian ranchers can still arrange a cattle drive to US markets. New Zealand’s sheep would be very tired after their 11,160 plus miles swim to China.

Still, you can’t dismiss the fact that AUDUSD and USDCAD trade very closely together although the link fractured in the latter part of June up to and including yesterday.  Apparently all is forgiven, today. AUDUSD plunged while USDCAD rose.

USDCAD and AUDUSD daily chart showing the divergent directions of those crosses
Source: Saxo Bank 

What if...?

The CME FEDWatch tool shows a mere 12.9% probability of a US rate increase in September. What if the market has got it wrong? It wouldn’t be the first time.

The Janet Yellen Fed has a reputation for sending mixed or muddled messages. You don’t have to go far back in history to find proof — just May 2016. At that time, every Fed speaker on the circuit was pointing to improving economic data, falling unemployment and rising job gains as evidence to support a June rate hike. The debacle of the May employment data was dismissed as “just one data point”. When decision day arrived, the Brexit vote loomed and the “just one data point” proved to be an important point, and rates were left unchanged. Many analysts started questioning if US rates would increase at all in 2016.

Lately, that rhetoric has shifted slightly. The Wall Street Journal warns that now that financial markets have stabilised after Brexit, the Wednesday July 27 Federal Open Market Committee's statement could point out that the economy is on solid footing. It makes sense. 

The rebound in June US employment, the string of decent economic reports, including today's housing data, may have reset the FOMC back to May’s outlook, when a rate increase, sooner or later, was on the agenda.

Oil may undermine loonie

USDCAD will be heading into the FOMC meeting with a bullish bias exacerbated by soft oil prices. WTI has been declining steadily since peaking at $51.65/barrel in June. The downtrend accelerated with the move below $47.85/b and prices are currently testing support in the $44.70/b area. A move below $44.40/b puts a target on the $40.00/b area.

A bearish oil view is supported by a Reuters story today that said Iraq has been eating Saudi Arabia’s Indian lunch, and we are not talking about curry. 

Iraq became India’s top supplier of crude in June by heavily discounting prices. Saudi Arabia kicked off the oil price meltdown in November 2014 in an effort to recoup lost market share. It is hard to believe that the Saudis will ignore Iraq’s blatant grab. The US has no shortage of supply. US crude stocks remain at elevated levels. The International Energy Agency's July 13 oil market report warned that the “existence of very high oil stocks is a threat to the recent stability of oil prices”.

A hawkish FOMC, at a time when other central banks are contemplating fresh stimulus measures in a soft oil price environment will boost the US dollar and suggests that USDCAD will retest resistance at 1.3200.

Cattle roundup
 Canadian stockmen could drive their cattle to market in the US, 
if they felt like it. Photo: iStock

— Edited by John Acher

Michael O’Neill is an FX consultant at IFXA Ltd.


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