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.

The best performing currency last week was the CAD?!

The CAD was the best performing currency last week and it is has completely reversed its year to date performance from a negative to a positive gain since the Bank of Canada’s decision to keep rates on hold in mid-January. The CAD’s reversal of fortune can be attributed to firmer price of oil, stable equity markets, and to better economic performance with Canada’s biggest trading partner the USA. One prominent Canadian bank has gone so far as to proclaim that the worst is probably over for the CAD.

Looking at the daily chart of the CAD, there is good support around the 1.33 level and resistance around the 1.40 level. This trading range should contain future price action as long as the Canadian economy stabilizes, the price of oil continues to trade above the $30 range, and that the Bank of Canada remains on hold.

The stress factors that were driving the price action in the currency, bond, and equity markets from the start of the year have ebbed, for now. Those stresses were the volatility of the Chinese yuan, the fall in Chinese equity shares, the downward pressure on commodities, especially oil, and the fear that the US economy was showing signs of a recession. The fact that the CAD was the best performing currency last week speaks to this – the relief of anxiety over the stresses. On the opposite end of the spectrum, the ebbing of the collective stresses have been replaced by a new one – Brexit, "British exit", refers to the possibility of Britain's withdrawal from the 28-country bloc known as the European Union (EU), hence the 3.7% decline in the GBP last week.

The previous Friday, Prime Minister David Cameron had reached agreement with other EU leaders on changes to the U.K.’s relationship to the bloc. He laid out the key arguments he plans to use in his campaign, arguing that Britain is better off in terms of economic and national security within the EU, the destination for a significant portion of the U.K.’s exports. The GBP was actually buoyed by the agreement. However, the GBP quickly changed course and its losses accelerated after Boris Johnson, London’s mayor and one of the U.K.’s most prominent politicians, said he would campaign for Brexit. Johnson, a contender to become prime minister one day, is now the most high profile politician to back the “leave” campaign ahead of a referendum, now set for June 23.

How bad was the GBP’s fall last week? – it was down more than 500 pips, slicing through 30-year generational support at the 1.40 level. Since 1986, the GBP has experienced only 3-4 periods below $1.40. Was the move warranted? Frankly, no one is certain what Brexit would mean for the UK and Eurozone economies (after all, it’s never happened before), so because of this uncertainty traders tend to sell first and ask questions later. Last week’s losses have left the GBP technically oversold, and we should expect some sort of relief rally – although more selling would not be unusual.

Brexit would most certainly lead to Scotexit - Scotland exiting the United Kingdom. For the rest of Europe, the threat of Brexit has also opened up a Pandora’s box of fears about EU itself. If Britain did leave the EU it would open up the door to other EU countries which are unhappy with the current union. Little wonder then that euro has been drifting lower along with the GBP as investors grow increasingly wary of the whole region. Hyperbole you say! Then why did this weekend’s G20 warn against an exit from the EU?