Yellen Keeps USD on Downward Trajectory, BoC Catapults CAD With Hike


Highlights:

Wednesday was not a good day for those who woke up with short exposure on the Canadian Dollar. While the bar was high for the Bank of Canada, led by Governor Stephen Poloz, it’s fair to say Poloz & Co. cleared the hurdle by noting the output gap (potential GDP less actual GDP) in the Canadian economy was closing causing fixed income traders to price in another hike later this year. Short-term Canadian yields continued their impressive run to close the gap to US 2 year yields. In May, near the time USD/CAD traded as high as 1.3795, the spread between the US 2Yr Yield to the CA 2 Yr Yield was 63.5 bps. The fall in the sovereign spread expresses the view that over the coming years the Fed reference rate was expected to hold a significant premium over the Bank of Canada. After Wednesday’s rate hike, the spread between the sovereign yields fell to 15.6bps and helps to explain the sharp reversal lower in USD/CAD since May (see chart below).

Trading CAD? You may like this: USD/CAD Plummets As BoC Does Not Look To Be One And Done.’

Another point traders should keep in mind is that while the Canadian Dollar has done the heavy lifting in the near 6% drop in the last 2-months, the trend could continue lower if USD weakness were to accelerate. On Wednesday and Thursday, Fed Chair Janet Yellen expressed concern and uncertainty about how much and when inflation would respond while adding that US rates will not need to rise much to reach “neutral.” In Fed speak, the neutral rate is known as the level at which the Fed is neither accommodating or tightening. If US inflation weakness persists (we get CPI on Friday to confirm), the neutral rate will continue its long-term trend lower, and a weaker USD would likely be the result.

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As Yellen was speaking, a market in addition to USD/CAD that had traders attention was USD/JPY. A rather strong reversal from Tuesday’s high of 114.50 to below 113 on Wednesday. Since March, USD/JPY has found resistance at the 114.50/115 zone and a further drop in UST 10Y yields, which hold a near decade high correlation to USD/JPY would likely reapply pressure to USD/JPY that has been absent since early June. The Bank of Japan will meet on July 20 to announce their rate decision that is fully expected to stay at -0.10%, but a further announcement on Yield Curve Control could provide volatility in USD/JPY.

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What appeared to be a day in which Crude Oil would rally off long-term support when the DoE showed the US experienced the largest supply drop since September remained a disappointment for Bulls. WTI did manage to settle above $45, but an OPEC report showed that current production is above implied 2018 demand according to their first 2018 outlook. Some trader may be encouraged by the announcement of an extraordinary OPEC meeting on July 17, but two rounds of production cuts leave the market in doubt that OPEC can provide the ‘shock and awe’ that was expected.

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Closing Bell’s Top Chart: July 12, 2017, LT USD/CAD chart shows breakdown may mirror H1 2016 Drop

Yellen Keeps USD on Downward Trajectory, BoC Catapults CAD With Hike

Chart Created by Tyler Yell, CMT

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The sentiment highlight section is designed to help you see how DailyFX utilizes the insights derived from IG Client Sentiment, and how client positioning can lead to trade ideas. If you have any questions on this indicator, you are welcome to reach out to the author of this article with questions at tyell@dailyfx.com.

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France 40: Retail trader data shows 41.8% of traders are net-long with the ratio of traders short to long at 1.39 to 1. The number of traders net-long is 38.8% lower than yesterday and 28.3% lower from last week, while the number of traders net-short is 83.3% higher than yesterday and 46.4% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests France 40 prices may continue to rise. Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger France 40-bullish contrarian trading bias. (Emphasis mine)

Germany 30: Retail trader data shows 31.5% of traders are net-long with the ratio of traders short to long at 2.17 to 1. The number of traders net-long is 33.9% lower than yesterday and 34.9% lower from last week, while the number of traders net-short is 43.1% higher than yesterday and 46.5% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests Germany 30 prices may continue to rise. Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger Germany 30-bullish contrarian trading bias. (Emphasis mine)

Written by Tyler Yell, CMT, Currency Analyst & Trading Instructor for DailyFX.com

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