CP25 – USD/CAD

USD/CAD:

(CORE) POSITION TRADE
TRADE REFERENCE: CP25
TRADE DIRECTION: SHORT
PLEASE NOTE: This Trade was featured in the DRIVE THRU blog #412 dated 16.05.2021
TRADE STARTED: 16^th May 2021
EXPECTED TRADING PERIOD: Q4 2021 – thru 2023

USD/CAD: IS THE LINE OF LEAST RESISTANCE LOWER?

It’s really hard to operate in the Financial World at any level at the moment and not hear or read about inflation in the U.S., targets, overshoots, run hot, average inflation ... whatever. Usually, inflation commentary is followed immediately by TAPERING and the FED policy looking ahead.

On 21^st April 2021, The Bank of Canada became the first major Central Bank to TAPER its asset purchases. Basically, a reduction of 33% from CAD$4 billion per week down to CAD$3 billion per week. This was the first G10 Central Bank to make this HAWKISH move on monetary policy.

The result of the TAPER was an appreciation of the CAD$ against the USD$ by 1.5 cents. This was a huge initial move, which has just expanded. Just prior to the BOC announcement the USD/CAD sat at roughly 1.2650, we are now sub c.1.2100. In the past month the CAD$ has risen over 3% against the USD, this is a big move whichever way you slice and dice the numbers.

A little history...

Over my 10+ years of trading in this market, I do not get FOMO, I do not get upset if I miss trades, and believe me, I miss lots of trades. I am here for the long haul, I take a “Steady Eddie” approach as often as I can, waiting for the best value price entry based on my macro views, beliefs and thoughts.

The USD/CAD is one of my LEAD INDICATORS that I look at every morning, as I set up my day. I look for correlations to OIL, the VIX and look for comparison moves with the AUD/USD, which I believe is the lead commodity currency for a number of reasons that I do not need to highlight here right now. The USD/CAD move lower of over +500 pips was large. Right now, the CAD to a large extent is leading commodity currencies, and I cannot ignore this.

It all sounds great...

A clear directional trade, however....

Last Wednesday and Thursday on the back of the U.S. inflation Data (CPi) and (PPi) we saw strong data released which the markets have interpreted as being inflationary to the extent that the FED may have to review its stance on how it has claimed it will deal with inflation from a Monetary viewpoint.

This follows the prior weeks’ poor non-Farm payrolls (266,00 new jobs) after which, the markets then believed that Jerome Powell and The FED were Demi-Gods based upon their desire to see the data first and confirmed with trend before acting. The belief being they knew issues were deeper and much more complicated than the markets naive approach

Technically and Fundamentally we have the usual conflicts that follow a large move with a currency pair.

Did we see a false move, this time a False Breakdown?
We definitely saw a powerful reversal move back c.150 pips.
Was this just a first test with a usual reversal and the BEARISH trend is going to resume, or are we moving much higher, with a strong reversal?

So, what am I looking at?

FUNDAMENTALLY:

Based upon the fundamentals listed below, the line of least resistance move is to the downside, but I cannot ignore the inflation data.

USD$ to continue to be sacrificed by the FED.
FED TAPERING not even a discussion topic yet.
FED will let inflation run high before looking to control. Is this still valid?
STIMULUS to remain in place until unemployment levels settle lower.
BOC now with a HAWKISH TONE. As economy moves forward further moves with monetary policy adjustments are expected.
OIL has a part to play here as well. It represents about 10% of the Canadian GDP and OIL is recovering with prices in the USD$60 – USD$70 price range, which indicates to me that the previous headwinds have now subsided.
Finally, the COVID-19 pandemic is starting to look like it’s starting to appear in the rear-view mirror in Canada. This should be CAD supportive.

TECHNICALLY:

The USD/CAD broke the 2017 lows at 1.2060. This also confluences with the 50% retracement of the 2011 lows to 2015 highs.
The 1.2060 break lower, triggers a massive DOUBLE TOP move from the 2015 and 2020 highs. The measured move here would be to 0.9430.
A massive move sub-parity seems highly unlikely from my perspective.
A break below 1.2060 and a weekly close above that level could indicate a FALSE BREAKDOWN despite the spike to 1.2210.
We closed the week at: 1.2107.
Last Friday we broke lower again but only as far 1.2080.
The USD/CAD looks broken.

THE MACRO CENTRAL BANK PERSPECTIVE:

THE BANK OF CANADA (BOC) and THE FEDERAL RESERVE (FED):

The trade with this pair should be reasonably straightforward.
FED is prepared to sacrifice the USD = USD weakness
BOC has started TAPERING = CAD strength
This will / should continue into the future as economy recovers.
SHORT USD/CAD should be the trade.

There is a caveat though from this macro perspective. How long will the BOC like continued CAD strength against the USD and other countries?

One could argue they were a little concerned at 1.2500. What would they be thinking at 1.2000 or 1.1500? I would imagine the deeper the move lower, the more concerned Tiff Macklem (BOC Governor), would be and at some point, he would react. With the DOUBLE TOP measured move to 0.9430, I would imagine he would have a very twitchy bottom.

TRADE UPDATE - 14.08.2022: