CAD/JPY: The right cross

The advantage of using technical indicators is their efficiency and precision of signals. However, the challenge to systematic traders occurs when fundamental forces change. Ultimately, price patterns reflect fundamentals such as economic growth, interest rate changes and inflation. Awareness of impending changes in fundamentals, when overlaid with technical analysis, can provide an edge to traders by giving clues to future direction or changes in established trends. Cross pairs, (currency pairs that do not involve the U.S. dollar) provide an excellent context for combining fundamental analysis with technical analysis. In the coming months, one of the best fundamental opportunities is in the Canadian dollar/Japanese yen (CAD/JPY) currency pair. 

The CAD/JPY cross is a battle between expectations for the Canadian currency versus expectations regarding the Japanese yen. Realizing this, there are two main fundamental forces affecting this battle. 
The first is expectations for crude oil and the second is expectations on the success of negative interest rates in Japan. Any technical determination of direction needs to consider these forces.   

The Canadian dollar is highly correlated with the price of crude oil. The current price of crude, $44 per barrel  at press time, is nearly 70% above the lows of February 2016, when it reached $26.21. If crude stabilizes and rallies into the $50 range, the fundamentals will support a rising Canadian dollar. Turning to the yen, the recent strengthening of the yen against the dollar, close to the 106 price point, has caused the yen to enter a fundamental fear zone, where such strength undermines the goals of stimulating the Japanese economy. While the USD/JPY may very well get stronger, intervention risks also will rise. 

The 95-100 price range in yen futures can be considered to be inviting intervention. A stronger yen against the dollar is certainly possible, but not for long. From a fundamental analysis perspective a bullish outlook makes sense in trading the CAD/JPY pair. If crude oil gets stronger and the yen nears the “intervention zone” we have a strong fundamental case for a bullish outlook on the CAD/JPY pair (see “Loonie/yen fundamentals align”).  This means that traders who come to this conclusion will look to buy the CAD/JPY on dips for long-term targets. Appropriate reward-to-risk ratios need to apply. Traders should consider a 3:1 reward-to-risk standard. 

The wild card in trading the CAD/JPY is the U.S. dollar. A weak dollar, resulting from stock market sell-offs or postponement of interest rate increases this June, will strengthen the CAD, but it also will tend to strengthen the yen. A weaker dollar likely will spur an increase in oil prices. Of course, crude oil supply variations will play an important role as well. A weaker dollar scenario, therefore, still supports a bullish direction on the CAD/JPY pair. Let’s consider a stronger dollar scenario. If U.S. interest rates rise, or are expected to rise, a stronger dollar will counter Canadian strength and may reduce bullish conditions on oil, but it  also will increase yen weakness. In this scenario, position traders of the CAD/JPY also should consider buying on dips. 

The advantage of trading cross pairs is that it is a pure play on the fundamentals of two currencies. Often dollar fundamentals can overwhelm a currency and move where dollar fundamentals dictate without regard to the other side. Conditions point to a rise in the CAD/JPY based on fundamentals in both the yen and the loonie. Reaching the highs of September 2007 of $122 is highly unlikely, but a target of $100 last obtained in December 2014 offers nearly a 1600-pip gain from the current $84.9 price.

About the Author

Abe Cofnas is author of “Sentiment Indicators” and “Trading Binary Options: Strategies and Tactics” (Bloomberg Press). He is editor of binarydimensions.com newsletter and can be reached at abecofnas@gmail.com.