USD Rally Crushes Loonie

 | May 26, 2015 12:31PM ET

  • USD spikes upwards in today's session
  • USD/CAD rally not matched by WTI price move
  • Rough seas ahead for S.S. Loonie

    • By Michael O'Neill

    It was a mere week ago that USD/CAD was threatening to break below the long term uptrend from last August and head toward the 1.1600 area. Today, however, it’s a new world order: USD/CAD has broken strong resistance in the 1.2370-90 area which will lead to a retest of the 1.2550 area.
    The sad part is that it's not the loonie’s fault.

    The Canadian dollar is being sold on the back of a widespread US dollar rally against the G10 currencies as long dollar positions get reloaded. The US dollar correction, evident from mid-April (when EUR/USD rebounded to 1.1460 from 1.0515), appears to have run its course, a view supported by the move below 1.0950 yesterday.

    The massive reduction in speculative short EUR/USD positions is evidence of both the correction and the capacity to reestablish the bearish EUR/USD view.

    The future is the past

    The January to March themes of rising, recovery-fuelled US interest rates contrasting with Eurozone rate cuts, economic weakness and concerns surrounding Greece have roared back to prominence after seemingly lying low throughout April.

    Rising inflation pressures indicated by Friday’s CPI report refocused traders on US rate hike risks (a September bump is still the economists' favoured date) and gave the dollar a bid. Federal Reserve chair Janet Yellen reminded markets that she still expects a 2015 rate hike in a speech delivered last Friday afternoon.

    Unfortunately, traders were distracted by long weekend holidays in the UK, most of Europe and in the US, leading to the delayed reaction that we saw today.

    Greek interior minister Nick Voutsis added to EUR/USD’s woes when, as reported by the BBC, he said "the four installments for the International Monetary Fund in June are €1.6 billion, this money will not be given and is not there to be given". That news came out on Sunday but it wasn’t until today that its full effects were felt in EUR/USD trading.

    USD/CAD has soared by over 0.0270 points since Friday, a rather large two-day move considering most FX markets were closed yesterday. And all of these losses are because the Federal Open Market Committee may raise US rates from 0.00-0.25% to 0.25-0.50%?

    FX markets seem as shocked as the guests at the red wedding in Game of Thrones.
    Janet Yellen believes that the Fed will raise rates in 2015, as do most of the FOMC members. And when they do, who will be surprised? Various Fed speakers have reiterated that rate hikes will be both data-dependent and gradual.

    Meanwhile, the Bank of Canada is more likely to raise rates than cut them. The latest speech from Governor Stephen Poloz was relatively upbeat and anticipates a 2.6% economic rebound in the second half of the year, supported by a rebounding US economy.

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    Still, it’s never over until the fat lady sings and she hasn't even taken the stage. The USD/CAD rally is occurring in the last week of the month with large US equity index gains suggesting USD/CAD buying for portfolio rebalancing on Friday.

    Friday is also the day when Canadian Q1 GDP data are released. Canada’s GDP is widely expected to be soft with the headline forecasted to show a gain of a mere 0.2%. If the data are much weaker than expected, and Canadian dollars are sold for month-end, 1.2550 is a likely target.

    Loonie selloff lacks oil conviction

    The lack of a corresponding correction in WTI oil questions the validity and sustainability of the latest USD/CAD rally. Despite evidence that the world remains awash in oil and global production remains at elevated levels, oil prices have been relatively stable for the past month.

    In the past few days, Goldman Sachs (NYSE:GS) has been warning that US shale producers are getting set to ramp up production. Others have warned that the US dollar rally will erase recent oil price gains.

    So, far, WTI prices are holding up and the summer driving season is being offered as one reason why prices may remain steady.

    Until WTI breaks decisively below $56.50/barrel, USD/CAD gains may be unable to crack above 1.2550.