Canadian Dollar

A dispassionate discussion of the impact of the sequester and implications for investors. I look also look at how the dollar has performed since QE3+ was announced and it is not what many might have expected.

Instead of looking at the daily bar charts for the major currencies that we provide every week, given the large moves, we thought it might be helpful to look at the longer term charts.  It is one thing for pundits and other observers to argue that QE drives currencies down, it quite another to operationalize and use that as a decision-making rule for investing or trading the foreign currencies.  The way people make money in the markets is not being right more often, but disciplined risk management.  Technicals allow one to quantify risk and admit where one can be wrong.  

While the sell-side has been vociferous about the fact that earnings are troughing, that consensus growth expectations are not miraculous, that equities are discounting that awesome reality; it appears Goldman Sachs' 'Swirlogram" - which we initially discussed here - is pointing to what we have been seeing for months - a slowdown in their global leading indicator dead-ahead.

Every voice in the FOMC minutes is not a voting member. Bernanke, Yellen, Dudley are the keys and they are committed to QE. That is a descriptive claim not normative. Debt market has shown little reaction to FOMC minutes compared with the dollar and stocks. PBOC drained, but did not really tighten monetary policy. Euro zone PMI poor and gap between Germany and France grows. And what's up with Abe's trip to the US ?

With the end of Asia's lunar new year celebration and the return of the US and Canadian markets after yesterday's holiday, there is full liquidity in the global capital markets for the first time in over a week. The currencies are mixed, with the yen, sterling and the Australian dollar posting modest gains, while the euro, Swiss franc and Canadian dollar have heavier tones.

The Chinese yuan has weakened for the second day after returning from the extended holiday and is near 2-month lows. After reversing lower yesterday, the Shanghai Composite led the regional bourses lower with a 1.9% decline. The Composite is approaching its 20-day moving average (~2365) which it has not traded below since early December. European equity markets are higher and the Dow Jones Stoxx 600 is up a little more than 0.5% led by consumer goods and basic materials. Of the main industrial sectors, only telecom is lower. European bond markets, core as well as periphery are lower.

Broadly speaking, we identify five factors that will shape foreign exchange rates in coming days.

An overivew of the price action in the foreign exchange market and what it might mean in the week ahead.  

Here is a review of the technical condition of the major currencies.  In my professional experience, I know few purist fundamental traders in the foreign exchange market.  Even for those, like myself, who study the macro economic and political fundamentals, technical analysis allows us to quantify the risk. Those who make money in the markets, do not do so because they are right more often, but rather they are disciplined risk managers.  Technical analysis provides a way to manage the risk by helping to identify where we are wrong.    It is offered here not as a substitute for fundamental analysis, but as a complement.  

Here is an oveview of the forces that are driving the foreign exchange market and price targets for the euro and yen.  We identify the ECB meeting as a potential challenge to the existing price trends, but expect it to see the tightening of financial conditions in the euro area as partially a reflection of positive forces, especially that banks have reduced, on the margins, the reliance on ECB for funding.  Draghi will likely attempt to calm the market down with words not a rate cut.  Also we see the "currency wars" as being exaggerated, not just because the foreign exchange market has alsways been an arena of nation-state competition, but that it is primarily in the realm of rhetoric among the G7 countries.  Few, including Germany, who have expressed concern about what Japan is doing, have objected to the Swiss currency cap.  There is not a bleeding over into a trade war.  The push back against the Japan (among the G7) appears to have slakcened a bit.  Officials prefer Japan not provide price targets for bilateral exchange rates (like dollar-yen), but if stimulative monetary and fiscal policy weakens the yen, that is ok.  

There has been a tightening of European financial conditions. Two more pieces of evidence were reported today. This issue may very well overshadow other issues at Draghi's press conference next week. German 2-year rates are moving above the US-- a 30 bp swing since early Dec. Meanwhile, US rates are rising relative to Japan. The dollar-bloc (and sterling) continue to under-perform. We also look at the US economic calendar for the day that features the ADP employment estimate, the first look at Q4 GDP and the conclusion of the FOMC meeting.

Here is a weekly over view of the currency market from a technical perspective.  The divergence between the performance of the dollar against the euro-bloc, with the exception of sterling, and the other major currencies is noteworthy.  In the analysis, I suggest a few opportnities for near-term contrarians.  I fully appreciate that some readers eschew technical analysis and regulate it to the same space as numerology and witchcraft.  Yet, even still, it is useful to recall Keynes' view that the markets are like a beauty contest and the trick is not to pick who one thinks is the most beautiful, but to pick who others will think most beautiful.  Moreover, technicals allow one to quantify how much one is willing to lose in a way that fundamental macro-economic analysis doesn't.  It is a tool then for risk management.  

Currency wars have captured the imagination of many. However, the modern history of the foreign exchange market demonstrates that is has always been an arena in which nation-states compete. Typically central banks want the currency's exchange rate to affirm not contradict monetary policy. The synchronized crisis and easier monetary policy makes it appear that nearly ever one wants a weak currency. Yet most officials are on low rungs of the intervention escalation ladder. Moreover, there is no sign of it spilling over to a trade war. Has any one else noticed that Japan's largest trading partner and regional rival China has been quiet, not joining the the chorus of criticism?

The US dollar is trading firmly. The official verbal commentary this week by Europe's Juncker and Japan's Amari were more disruptive noise a true signal. These mis-directional cues whipsawed short-term participants and served to obscure what was really happening. One of the most important take aways, it seems, from this week's action is the narrowing of the breadth of the dollar's decline. It is really limited to only the euro...

There have been some large moves in the foreign exchange market in recent days.  The euro posted its largest rally in four months last week.  The yen has fallen to its lowest level against the dollar since June 2010 and extended the declining streak to nine consecutive weeks, something not seen since 1989.  The Canadian and Australian dollar rose to multi-moth highs, as did the Mexican peso.  

In last week's technical note, we suggested the key question whether the sharp drop in the major foreign currencies following the avoidance of the full fiscal cliff in the US was trend reversal or overdue correction.  We favored the latter and looked for the underlying trends to continue.   They did.  

Now market participants face a different question.  Given the out-sized moves, have the trends become stretched?  The answer, we propose, is more nuanced than last week.  There is not one answer for all the major currencies we review here.

One of the most important decisions participants in the foreign exchange must make is whether to view the dramatic pullback in most of the major foreign currencies seen in the early days of the new year as a reversal of the trend or as simply an overdue correction.   Our technical analysis sides with the latter and we anticipate renewed dollar weakness in the period ahead. 

We would be forced to reconsider if the euro fell through the $1.2980 area or if sterling fell below $1.60.  Although the dollar's sharp gains against the yen have left it over-extended, we see no compelling technical sign that a reversal is at hand.  Just like ECB's Draghi wielding Outright Market Transaction scheme drove down Spanish and Italian yields, Japan's Abe's rhetoric has been sufficient to drive the yen down without lifting a finger or spending cent.

The holiday week saw the dollar consolidate against most of the major currencies.  The yen was the main exception as its losses were extended under the aggressive signals coming from the new Japanese government.   

At the end of the week, the other key consideration, the US fiscal cliff made its presence felt.  The recent pattern remained intact.  News that gives the participants a sense that the cliff may be averted encourages risk taking, which means in the foreign exchange market, the sale of dollars and yen.  

News that makes participants more fearful that the political dysfunction failed to avert the cliff and send the world's largest economy into recession, generally see the dollar and yen recover.  This is what happened in very thin markets just ahead of the weekend as Obama's ling last ditch negotiating stance seemed to reflect a retreat from his earlier compromises.