Market Watch: Canadian Dollar

Is it time for the Canadian Dollar to make a significant correction against its Australian counterpart?

The Canadian dollar is traditionally one of the more difficult currencies to predict in terms of medium to longer term movement, given direction is principally dictated by a number of factors outside the confines of the Canadian economy and the monetary policy moves of the Bank of Canada, namely 1) the general trend in global commodity prices and 2) close affiliation and thus link to the performance of the US economy and the US dollar.

It is thus a risky currency to trade, although over the past 12 months it has generally traded within a fairly confined range against the US dollar, while trading a little stronger against the Euro for all of 2013. The Canadian dollar has not had anything like the same inflated gains achieved by the Aussie and New Zealand dollars since the turnaround in global financial markets, but this is thanks to the much more accommodative interest policy adopted by the Bank of Canada, as against that adopted by the Central Banks in Australia and New Zealand. Interest rates in Canada have remained at 1.00% while the higher rates on offer in the Aussie dollar (3% + up until recently) meant that any speculative holding trade involving commodity currencies has generally gone on the Aussie dollar. The recent sharp fall in metal prices and the reduction in overnight rates (to 2.75%) announced by the Reserve Bank of Australia last week has triggered some dilution in this holding trade, and the loonie is now up 5% against the Aussie in the past month. However, the pair are due a further correction given the Aussie is still trading almost 30% higher against the loonie than when the pair last traded at a fully corrected price back in early 2009. Of course the problem with being bearish on the AUD/CAD pair is the punitive overnight cost of the interest rate differential (2.75% Vs 1.00%), but the signs do indicate this pair should make a significant move downwards, certainly down to 95 and possibly down to 90, through the course of this year.

But, and this is an important but, the Canadian dollar will only make significant gains against the Aussie on the back of a move downwards in AUD/USD, and thus a good hedge to take on in tandem with a sell of AUD/CAD, is to sell USD/CAD. While not the perfect hedge, it will significantly reduce the risk of holding AUD/CAD in the medium term, while the interest rate differential in selling USD/CAD is in the traders favour (0.25% Vs 1.00%). This strategy is for an initial 3 months.

Ted - May 15 2013