USD/CAD imbalance in the making?
Courtesy of The Province
Ok, everyone knows I hate to make bold claims because, as a trader, my opinion could change in a heartbeat. However, I like to point out potential imbalances that could turn into trades. One such imbalance that I see in the making is the recent rally of the Canadian Dollar. The currency has rallied considerably against the Dollar, in fact, more so than any of the majors over the last month. The rally, which has finally taken a breather, seems to be largely due commodity (namely energy) price increases over the same period as well as the realization of Canada’s much better capitalized financial system.
The recent rally seems overdone for a number of reasons:
- While CAD tested new highs (USD/CAD lows), crude did not even attempt to test its June highs.
- BOC Governor Carney has repeatedly expressed concerns over a strong CAD
- Sentiment is shifting: Evidence this week shows traders are starting to reward the USD on good US news instead of buying “riskier” currencies against the dollar. When the “rules of the game” start changing, trend reversals are often not far ahead.
- Key Canadian economic data have both shown much weaker results than expected (Ivey PMI: 51.8, Employment: -44.5K) in contrast to the positive results seen in the US data counterparts.
The key opposing risk to this analysis is if commodities start to stage another rally. If you would like to read more on this argument, check out Scotiabank’s monthly report for August 2009 at the fx bank research page. Otherwise, it’s advisable to play this by either putting on a small position and buying dollars as USD/CAD starts climbing or waiting until sentiment really starts to shift and allowing the move to show itself. In order to protect against the risk that the timing of this analysis is off, one of these methods is necessary.
As usual, these posts are here to provide a perspective, and not for recommending trades.
One Response “USD/CAD imbalance in the making?”
Hi Kris,
Here are several additional reasons to believe the CAD rally might be short-lived
1) the poor BoC yield. AUD is still at 3%, but CAD is at 0.5%.
2) automotive sales will tank after the junker trade in program ends.
3) longer term, commodities won’t stage a sustained rally (I think Q4 will not be good) until employment actually shows increases instead of smaller decreases.
IMHO, the best way to play this is with a bull call spread on $/CAD with a 6-8 month expiry. Long at 1.08, Short 1.15 or 1.16. you could almost get the whole position for free if you also sold a put at 1.0
Paul S