CAD Casualty

The CAD was the main casualty of the USD’s reversal, falling 1.95% on the week, which ended a nine week rally. The possible culprits for the drop in the loonie were the slump in the price of oil and/or the release of the Canadian Federal Budget.

The world’s eyes were on Canada last week as it became the first major industrialized country to opt for fiscal stimulus rather than rely solely on monetary easing. The Organization for Economic Co-operation and Development and the International Monetary Fund has stressed the need for governments to turn to fiscal policies instead of monetary central bank policies; and the Canadian government delivered by promising to spend more on infrastructure to boost growth. The Canadian Finance Department estimates that the stimulus spending will drive 0.5% of GDP growth. The government is putting the bulk of its effort on the middle class and expecting a positive spillover to the rest of the economy. The bad news is that federal finances will go from a near-balanced position of the past two years to big budget deficits of almost $30 billion (or 1.5% of GDP) for each of the next two fiscal years. Canada’s pristine balance sheet will be affected in the short term but with the current global backdrop this will be acceptable. The key for the currency will be for the medium term – will the government be able to reverse the deficits down the road? We will come back to this point in four years’ time.

With the cumulative burden of big deficits down the road, the CAD was weighed down more by the combination of a firmer USD and the lower price of crude. The price of oil approached the 200-day moving average around the $42 level last week and backed off after U.S. crude inventories jumped more than expected and gasoline stockpiles fell. The Energy Information Administration reported U.S. crude stocks rose by 9.4 million barrels in the previous week to a record total of 532.5 million barrels. Offsetting the build was a 4.6 million barrel decline in gasoline inventories. The EIA also said weekly production ticked down by about 30,000 barrels per day. This spells trouble for oil and the CAD as inventories are at all-time highs nearing full capacity as we approach the spring maintenance season for refiners.

The USD/CAD rate has moved up through the overhead downward sloping trend line drawn off the mid January high. The technical indicators are also aligned with the up move in the rate with the RSI rising and with the crossover in the MACD. A move to the 200-day moving average would be constructive. Also, if the price of oil were to fall below the shelf carved out at just above the $36 level then the USD/CAD rate could attempt to reach the falling 50-day moving average.

During the previous week, the US Fed’s actions sent the USD reeling but that all changed last week as the USD climbed out of the basement to the top of the heap. The USD was well bid all week as nearly half of the regional Federal Reserve presidents appeared more willing to support rate hikes than was the impression following the previous week’s Fed meeting and press conference by Janet Yellen. Of course, this may have been an attempt by the Fed to steer markets away from their post-FOMC conclusion that the Fed was safely out of the picture for the next few months. Thus, the regional Fed presidents were successful at injecting some speculation about the appropriate number of rate hikes this year and adding some uncertainty about a possible hike in the April or June meetings. Any time a regional Fed president is a little more hawkish or less dovish it is USD supportive.

Meanwhile, the GBP was at the bottom of the heap following the release of soft inflation data and an increase in the odds of the UK leaving the European Union in the June referendum in the wake of the Brussels terror attacks. With immigration as a key issue in the referendum, the GBP was knocked down as traders presumed that British voters might seek to distance themselves from the EU and the terrorist attacks that took place first in Paris back in November and now in Brussels. The February inflation reading added to the GBP’s pain. The 0.3% reading is unchanged on the previous month and was below the forecast of 0.4%.

Who let the Kangaroos out?

Who let the kangaroos out? It was that type of week, a risk-on rally. The risk-on currencies are led by the commodity currencies of the AUD, NZD, and CAD as it was a banner week for this lot as funds poured into the high yielding currencies. The GBP was able to slip into that club last week as it traded higher, despite the weakness of U.K. data. The GBP demonstrated incredible resilience as it corrected its oversold condition as Brexit fears abated, for now. As you can imagine, during bouts of risk-on trading the low yielding currencies or funding currencies would be the laggards and that is exactly what transpired last week. The low funding currencies of the EUR, CHF, JPY, and USD were at the back of the pack.

The AUD had its best week since October, having gained over 300 pips on the week. It wasn’t purely driven by the risk-on condition of the market, positive Australian economic data also helped. The Australian economy grew 0.6% in Q4, as consumer spending, housing construction, and public sector expenditure offset a fall in company investment and profits and export prices. The growth rate, which equates to 3% year-on-year and 2.5% for 2015, came in at the high end of economists' estimates. A smaller January trade deficit (A$2.94 bln vs. A$3.2 bln consensus) and a rise in the service PMI (51.8 vs. 48.4) also helped to lift the AUD. The Aussie also received a helping hand from the Reserve Bank of Australia, which left rates steady as widely anticipated. However, the most impressive aspect of the AUD’s performance is that it happened despite continued weakness in the China's PMIs last week.

Technically, the AUD could extend its recent strength as the risk-on theme of the market continues to run its course considering that there are no major U.S. economic reports on the calendar in the upcoming week; and against the backdrop of potential central bank easing from the ECB (March 10th) and Bank of Japan (March 15th). This also applies to the other commodity currencies of the NZD and CAD – they could move even higher along with the risk-on rally. Having said that, the momentum indicators are starting to show signs of over extension and warn of a possible correction or change in trend. The potential turning point may come from the US Federal Reserve meeting on March 16th. The Fed is not expected to hike interest rates but there has been enough improvement in the jobs report for the Fed to maintain a hawkish bias. This, in turn, would have the potential of turning the risk-on rally into risk-off.