What’s Behind the Sell-Off in USD/CAD?

The biggest mover this morning is the Canadian dollar which has rallied close to 300 pips against the US dollar and is closing in on the 1.20 level. What’s behind the move?

1. Major merger and acquisition flow. Mexican breadmaker Bimbo closed on a $2.38 billion acquisition of U.S. Bread making unit of Canada’s George Weston Ltd

Story in Reuters
Why does M&A flow Matter to Currencies

2. Oil prices are back above $40 a barrel and rising
3. OPEC Says Oil prices at $40-$50 is too cheap, prices need to be between $75 0 $100.
4. IMF says Oil May AVerage $50 a barrel this year and $60 a barrel next year

Source: eSignal

Source: eSignal

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US Trade Deficit Hits 5 Year Low, USD/CAD Soars

The US trade deficit narrowed materially in the month of November to the smallest since June 2003. Although the narrower trade deficit is normally something to cheer about, the details of the report indicate that the only reasons why trade improved was because of the fall in oil prices and slower domestic demand. The big story is in imports, which plunged 12 percent in November. Unfortunately the strength of the dollar did not drive stronger US demand for foreign goods but it did cut exports by 5.8 percent. The US dollar strengthened following the report but the gains may be limited because the report reflects the weakness rather than strength of the US economy.

Meanwhile Canada is at the brink of turning a deficit for the first time in 10 years. Their trade surplus shrank to 1.3B in November, the smallest since October 1997. The toxic combination of falling oil prices and weaker US demand for vehicles has caused exports to drop 6.8 percent the fourth consecutive month.

Unsurprisingly, USD/CAD has soared the following the better trade report from the US and weaker report from Canada. Expect the currency pair to hit 1.2375 as long as it holds above the 1.2150, today’s low.

Source: eSignal

Source: eSignal

Explosion in Forex Trading Ranges

Forex trading ranges have exploded over the past few months. The daily average trading range has doubled for all of the actively traded currency pairs in 2008, with some currency pairs even seeing a 200% rise in their average daily range.

However the big explosion in volatility has actually happened in the past 9 weeks. EUR/GBP, USD/CAD and the AUD/USD have seen the largest increases to their average daily range, but the range for the EUR/USD and GBP/USD has also increased materially.

More specifically, in 2007, the EUR/USD had an average daily range of 84 pips. Since October, its average daily range has been 267 pips, a more than 300 point rise.

Understanding trading ranges is very important because it plays a big role in developing effective money management strategies. I explore this concept in more detail in the second edition of Day Trading & Swing Trading the Currency Market.

EUR/GBP which use to known as one the range trading currency pairs saw its average daily trading range increase from 36 pips in 2007 to 142 pips since October, a whopping 400 percent rise. Say goodbye to the days of the hiding in low volatility of EUR/GBP because it is currency pair that has seen the largest expansion in volatility.

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Big Moves in the Currency Market

Most currency traders only have their eyes on the “majors” such as EUR/USD, USD/JPY, and the GBP/USD. Admittedly, these are the most liquid currency pairs, but sometimes opportunities could be missed if you are not also looking at the crosses. Trends are usually more powerful in the crosses than the majors and you may not have realized that some currency pairs hit multi-year lows today on an intraday basis:

GBP/JPY: fell to a 13 year low
NZD/JPY: fell to a 7 year low
CHF/JPY: fell to a 6 year low

On the upside:

EUR/GBP: hit a RECORD high
EUR/NZD: hit a RECORD high

Here are pairs that are closing in on significant levels

USD/JPY: 125 pips from 13 year lows (needs to break 90.92)
USD/CAD: 250 pips from 3 year highs (needs to break 1.3019)
NZD/USD: 130 pips from 5 year lows (needs to break 0.5193)
CAD/JPY: 110 pips from 8 year lows (needs to break 71.02)
GBP/CHF: 125 pips from 34 year lows (needs to break 1.7426)

Also on Monday, I indicated that the British pound was headed for 1.45. That target was reached this morning.

Here is the British pound chart:
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The Race to Zero Interest Rates

With the global economic downturn in full swing, one of the burning questions on everyone’s minds is who will be the first central bank to take interest rates to zero and how close will everyone else get?

We are in a global easing cycle and the varying aggressiveness of central banks around the world means that any country could be the first to see zero interest rates.

We expect December to be another active month for the foreign exchange market as central banks around the world take their interest rates to historically significant levels. There are 4 central banks with monetary policy decisions in the first week of December and all 4 are expected to cut interest rates. The closest to zero is the Bank of Japan, but having been there before, they are reluctant to revisit those levels. The US Federal Reserve and the Swiss National Bank have the second lowest interest rates. Both central banks are expected to continue to ease, but the Fed has been far more open about going to zero interest rates than the SNB. Realistically, Japan and the US will probably be the only ones to take rates all the way down to zero. Switzerland should be left with the second lowest interest rate when the dust settles followed by the Bank of England.

What Happens After Zero?
When a central bank runs out of room to cut interest rates, they resort to Quantitative Easing. This term was coined by the Bank of Japan in 2001 when interest rates were already at zero and the central bank stopped targeting the overnight call rate and turned to targeting a current account level. Their goal was to flood the Japanese financial system with liquidity by buying trillions of yen of financial securities including asset-backed instruments and equities.

It can be argued that the US has already engaged in Quantitative Easing as the government has recently announce plans to spend $800 billion to unfreeze the consumer and mortgage market. They have agreed to buy mortgage backed securities backed by government sponsored entities and could accelerate that if interest rates hit zero. Excess reserves have also increased significantly, driving the effective fed funds rate well below 0.5 percent. This would have been one of desired outcomes of quantitative easing. Last week, Fed vice chairman Donald Kohn said quantitative easing measures were under review at the central bank as normal contingency planning. The goal would be to encourage banks to lend more aggressively by coming in as a buyer at specified rates. Even though quantitative easing drove Japan into deflation, it was the key to turning around the economy and this is a risk that the US central bank may have to take.

Here’s where the major central banks stand and what is expected for the next meeting:

Federal Reserve – 50bp Cut Expected on 12/16

On October 29, the Federal Reserve took interest rates to 1 percent, which is near the record low reached in 2003 and 2004. While other countries have just started reacting aggressively to financial conditions, the Fed has been mounting cuts as far back as the middle of 2007. There has been no looking back since, as rates have been cut 425bp since 2007 and 250bp year to date. With interest rates near ultra low levels, the Federal Reserve has already resorted to unorthodox policy tools. More easing is expected with the markets torn between a 50 or 75bp rate cut in December. The FOMC statement will be particularly important this time around because the Fed will have the difficult decision of signaling a move to zero interest rates. In order to deal with this decision, they have expanded their monetary policy meeting from 1 to 2 days. Fed Chairman Ben Bernanke has remained dovish throughout the past few months which mean that another rate cut is practically guaranteed.

European Central Bank – 50bp Cut Expected on 12/04
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