Forex traders always are looking for opportunities and in the current economic environment of uncertainty and extreme negative U.S. dollar sentiment, two currencies are compelling: the Canadian and Australian dollars. Both are trading close to parity with the U.S. dollar, and both are commodity currencies. Canada is a resource commodity based economy with a $1 trillion gross domestic product (GDP). The Bank of Canada Commodity Price index shows that crude oil, natural gas and coal generate 34% of the index, while industrial metals compose 14%. As a commodity exporter, Canada has had a surge of capital inflow. But traders need to know that the index is now at parabolic extremes, reaching an apex of 90 degrees (see “Unsustainable?”). This is essentially unsustainable and traders should see a pullback coming.
Another problem for the loonie is its close link to the U.S. economy. More than 80% of Canadian trade is with the United States, and a U.S. slowdown translates into less expected demand for Canadian resources. The Canadian GDP is already indicating signs of a slowdown to 1.8% and Canada has experienced a current account deficit for the first time since 1999. In response to weak economic conditions, the Bank of Canada has cut rates to 3.5%. The result is that the price action of the USD/CAD pair is a fertile ground for range trading. The loonie benefits from rising oil and lower U.S. interest rate expectations, but gets undermined from a worsening U.S. economy. As a result, we have seen prices breaking parity with the U.S. dollar, strengthening to .9221 on Nov. 6, but also ranging back to 1.0366 on Jan. 21. Using 1.00 as a pivot, we now have a 500 pip range between support and resistance. Sentiment patterns, as indicated in the forex options market, are a good gauge of direction. Currently trader sentiment is virtually indifferent to direction for this pair, which means that the implied volatility of both puts and calls for the USD/CAD pair are equal. With options traders split, we could see a range bound market.
The Aussie offers another commodity connection currency that compels more attention. Australia has been a top performer due to its commodity role.
The surge in the CRB Reuters U.S. Spot Raw Industrials, which tracks 22 commodities that are sensitive to global growth, shows the correlation between commodities and AUD, but is also at extreme unsustainable inclines. It tracks the AUD/USD pair closely. If the commodity boom continues, going long the Aussie is a logical choice (see “Commodity affect”).
But the key driver towards parity is the interest rate differential between the United States and Australia. The United States is cutting rates while Australia has raised them to 7.25%. Australia faces inflation nearing 4%. The interest rate differential is widening to more than 4%. As a result, the forces of capital flow argue for selling dollars and buying Aussies.
It’s important to realize that the forex trader isn’t trapped within an either or directional choice of trading the USD/CAD or the AUD/USD. The AUD/CAD pair offers the opportunity of trading the relationship between the two. The forex trader should look for extremes and play a reversion. At this time, the AUD/CAD cross pair is showing a potential reversal and offers a long-term short.
Abe Cofnas is president of learn4x.com LLC. E-mail him at firstname.lastname@example.org.