Blast From The Past

If you're looking for support on the USD/CAD currency pair, then break out your platform shoes and polyester leisure suits, because the last time the Canadian Dollar reached this level vs. the U.S. Dollar, Jimmy Carter was in the White House and the Bee Gees and Steve Miller were on top of the music charts. While the Canadian Dollar continues to "Fly Like an Eagle", the U.S. Dollar is barely "Stayin' Alive" (see figure 1).

Figure 1: USD/CAD plunges to a 30-year low. Source: Saxo Bank

Now that the USD/CAD pair has traded below 1.09 for the first time since 1977, the possibility exists that the two currencies will achieve "parity" – the point at which one U.S. Dollar is equal in value to one Canadian Dollar – within the next year or two.

The Loonie also continued its rampage against the Japanese Yen, as the CAD/JPY pair continued to skyrocket to multi-decade highs (see figure 2). The Yen continues to under perform nearly every major currency, as traders continue to build "carry trade" positions that entail the selling of low-yielding currencies. Japan's benchmark interest rate currently rests at a mere 0.5%, making it a prime target for this type of trading strategy.

Figure 2: The Canadian Dollar runs wild vs. the Japanese Yen. Source: Saxo Bank

Why is the Canadian Dollar in the mood to "boogie all night long"? Strength in the price of commodities, such as gold and oil, have boosted the Canadian economy because of Canada's status as a producer and exporter of such goods. The Bank of Canada has held the benchmark interest rate at 4.25% for the past year, but economic strength is leading traders to believe that rates will begin to climb again, beginning this summer.

What is driving commodities prices higher? Demand from countries such as India and China, populous countries that are experiencing phenomenal growth, are the main culprit behind the demand for base metals and oil. With no slowdown in sight to the commodities rally, and inevitable higher yields, watch out for continued strength in the Canadian currency.

Greenback Hanging Tough

Although the overall performance of the U.S. Dollar this decade has been pretty dismal, the greenback is fighting back in the month of May. The U.S. Dollar Index has made a series of higher lows and higher highs over the past month, providing at least a temporary reprieve for USD bulls (see figure 3). Despite the pummeling it has taken from the Canadian Dollar, the buck has held up particularly well vs. the Japanese Yen, and has fought the Euro and Great Britain Pound to a draw in recent weeks. Does this mean that the downtrend in the U.S. Dollar is over? Not likely, but a strong dollar would create some trading opportunities in the near term.

Figure 3) U.S. Dollar Index grinds higher after a major move lower. Source: FX Street

The $1.2 Trillion Question

China is flush with cash due to its huge trade surplus with the U.S., and now sits atop a growing mountain of U.S. Dollars and dollar-denominated assets. The question is, what will China do with its stockpile of 1.2 trillion U.S. Dollars? This week we saw a glimpse of what may come as China's new state-run investment agency took a $3 billion stake in the Blackstone Group, a U.S. private equity firm. The stake is equal to less than 10% of the company, allowing China's investment agency to "fly under the radar" and avoid U.S. government scrutiny. Don't be surprised if you see more deals of this nature in the near future.

Maybe They Could Call It The "Groonie"

Bank of Canada Governor David Dodge said Monday that a single currency, combining the U.S. "greenback" and the Canadian "Loonie", might someday be adopted in North America. The unified North American currency, which would also include the Mexican Peso, would be similar in nature to the European Union's Euro. Dodge said the countries involved would have to "tear down borders in terms of labor flows" to make a joint currency work. Personally, I hope this money merger never happens – after all, the Loonie has been one of the best currencies to trade from the long side for the past five years. Also, it would be a tough sell to convince Canadians to forsake the smoking-hot Loonie for a currency combination that includes the woeful U.S. Dollar. Fewer currencies would lead to increased ease of international trade, but would also mean fewer trading opportunities for currency traders everywhere.

China Strikes Up The Band

China has agreed to allow its currency, the Yuan, to float in a slightly wider band vs. the U.S. Dollar. On Friday, China central bank said it would allow the Yuan to rise or fall a maximum of 0.5% against the greenback per day, up from 0.3% in the current trading band. U.S. politicians, who have been threatening to place tariffs on Chinese imports, greeted the move with skepticism. The Yuan never moved the maximum amount permitted under the previous daily limit, with the biggest move this year against the dollar a 0.22% gain on May 11.Since China ended a strict peg to the dollar in July 2005, the Yuan has risen less than currencies such as the South Korean Won and Malaysian Ringgit. U.S. Treasury Secretary Henry Paulson will push China for further concessions during talks in Washington starting on May 22.

In addition to widening the band, the People's Bank of China (PBOC) raised interest rates for the second time in just over two months and tightened access to credit, in an effort to cool off its red-hot economy. China's economy grew at a blistering 11.1% rate in the first quarter of the year. The central bank also announced that it would hike the required reserve ratio by 0.5-percentage point to 11.5%. By requiring banks to hold more money in reserve, the PBOC hopes to decrease borrowing and slow down its booming investment and construction sectors. The reserve requirement increase was the fourth since the start of this year and seventh since mid-2006.

Question of the Week

Q) Hi Ed! If I'm planning on holding on to a trade over several days as it reaches a longer range target, if news is coming out during my holding period, should I exit prior to the news then resume my trade after the news is released, or should I just ride out the swings with my stops in place...ignoring the news announcements during my holding period?

Ed Ponsi) Thank you for your question. Whether or not you should exit prior to news depends on two issues: the time horizon of your trade and the type of news that is about to hit the wires. If I were placing short-term trades, which tend to have close stops and exits, then I'm not going to hold a position through an economic news release. The resulting volatility could easily cause the price to hit my stop. On the other hand, if I'm in the trade for the longer haul, and trading with wider stops and targets, then most economic indicators will not chase me out of the trade – although there are some exceptions. First and foremost, I don't want to hold any positions during the U.S. employment report, because the Forex market's reaction to this news over the past few years has been dangerous and unpredictable. Another event to avoid is an interest rate decision by the U.S. Federal Open Market Committee, or FOMC. The wild swings seen after the announcement are usually a result of the forward-looking statement that the FOMC releases in conjunction with its decision, as opposed to the decision itself.

Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.

Here is a link to the original article on the recent surge in the Canadian Dollar.