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Article / 12 July 2016 at 15:30 GMT

Risk aversion risks have only faded, not disappeared

FX Trade Strategist /
  • Risk-off switched flipped to "on"
  • WTI recoups all of yesterday's losses
  • USDCAD range remains intact
 Don't get complacent. The risks haven't gone away. Photo: iStock

By Michael O'Neill

The pall of risk aversion sentiment that was draped over markets for the past few sessions has dissipated. In its place, a Pokemon GO fantasy world where traders believe central bankers like Kuroda, Carney and Draghi will open up the floodgates of new monetary stimulus and transform moribund economies into economic growth machines.

Like all fads, today’s positive risk bias will go the way of “Pet Rock”, Pogs, and “Mullets”. In a few days or weeks, traders will be saying “I can’t believe I fell for that”.

Risk aversion risks

The FX markets are rife with risk aversion risks, most of which are well known but have faded from consciousness for whatever reason. They are lurking just below the surface like a Great White off a Cape Cod beach and they are ready to take a bite out of complacent traders.

China: China has been the source of major market turmoil more than a few times in the past year. The stock market is very vulnerable to sharp down swings. The government is attempting to manage a “soft landing” and economic growth is declining. Despite official claims to the contrary, the government appears to want a much weaker CNY.

China is aggressively expanding its claims in the South China Sea even though The Permanent Court of Arbitration in The Hague ruled today, that they do not have any historic rights to justify their claims. China is on record for saying that the arbitration is non-binding as far as they are concerned. So what happens if the UN tries to enforce the ruling?

Russia/NATO: This is another powder-keg. Summer weather may be hot and humid in parts of the Northern Hemisphere but in the Russia/NATO area, it is frosty and freezing. NATO is aggressively deploying troops and weapons on Russia’s borders, ostensibly as a show of force to curtail Russia aggression. What could go wrong?

Middle East: Syria, Yemen, Afghanistan, Iraq. These conflicts are seemingly never-ending and always on the verge of triggering an explosion into risk aversion. It was only a couple of years ago that, according to President Obama, “Syria has crossed a line”. If it was a threat, it was rather empty. Daesh and Al Qaeda have yet to be subdued and their actions can quickly destabilise markets.

North Korea: The US slapped sanctions on Kim Jong-un and other officials for human rights abuses and Kim retaliated by cutting off its diplomatic link to the US. North Korea launched a submarine based missile on July 9. It failed, as have the previous two tests but they may get it right soon. If so, it dispenses of the need for a long range missile that could strike the US mainland, when a submarine could sneak up into America’s back yard and fire at will.

Cautiously optimistic Opec

Opec appeared cautiously optimistic in their July Monthly Oil Market Report. In a nod to Brexit, they downgraded their world economic growth outlook for 2016 to 3.0% from 3.1%, but left oil demand forecast unchanged. They also expected a stronger contraction in non-Opec supply in 2016.

Whip-sawed oil traders

Yesterday, oil traders were scrambling to hit bids. The world was awash in oil, US crude oil stocks remained at very high levels and the technicals were bearish. Today, all those troubles seemed so far away. ( apologies to Paul McCartney) WTI has recouped all of yesterday’s losses and then some.

The intraday WTI technicals are bearish while trading below $46.75.  The June downtrend line remains intact while trading below $48.40. A break below $44.40 would extend losses to $42.30 A move above $48.40 would snap the downtrend and extend gains to the June peak.

Chart: USOIL continuous 4-hour
 Source: Saxo Bank 

Loonie pulls back from brink

It wasn’t looking very good for the Canadian dollar, yesterday. The break of resistance at 1.3090 had USDCAD knocking on resistance in the 1.3145-50 area. That changed overnight.  The shift into risk seeking trades triggered a rebound in oil prices and USDCAD has retraced all of its post-payrolls gains. Next up will be the results of the EIA crude stocks weekly change report. If, and it’s a big if, this report shows a larger draw-down than expected, USDCAD will be back to 1.2920, where it was when last week’s report was released.

Wednesday, the Bank of Canada will add its voice to the Loonie direction debate. The BoC is unanimously expected to leave interest rates unchanged however there is a debate as to the degree of dovishness that will be in the accompanying statement and/or press conference. The Monetary Policy Report is expected to show downgraded economic forecasts as well.

The reality is that USDCAD direction is in the hands of general US dollar sentiment and oil prices and not domestic issues.

USDCAD technical outlook

The intraday USDCAD technicals are bearish. The break below 1.3090 should lead to a test of support at 1.2980. If broken, further losses would result in a test of the June uptrend line that comes into play at 1.2950. A break of this support would lead back to 1.2750. To the top, a move above 1.3090 should result in another test of resistance in the 1.3145-80 zone.
Longer term, the well-defined 1.2550-1.3150 range remains intact.

Chart : USDCAD 4-hour
Source: Saxo Bank

– Edited by Clare MacCarthy


Michael O’Neill is an FX consultant at IFXA Ltd

John Shaw John  Shaw
Fun times dead ahead Mike. Thanks for sharing.
Oh..... we must add in the increasing likelihood of a nice recession to boot. It's all based on free loans for cars right now.
If it happens fast enough, the know-nothing know it alls can blame it on Brexit.

That will bode well for Canada.
Michael O'Neill Michael O'Neill
Yessiree. Take a mortgage on your car Weekly payments for almost 10 years with negative equity for the first 7. Dumb and Dumber live!
Estuardorlemus Estuardorlemus
Thanks for updating us with such a good article. Have a good day Mike


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