Has the "early risers" club just gained a new member?

Has the early risers club gained a new member?

As we get closer to the end of Q2 some new themes are starting to develop; firstly, relative central bank stances seems to be the major theme right now, the minor theme is geopolitical risks and oil price volatility. This has big implications for financial markets. For now, stocks in the US are able to make fresh record highs on the back of continued accommodative monetary policy from the Fed, while they are ignoring rising oil prices and tensions in Iraq. However, in the FX market, although the central bank theme has led to big gains for GBP and CAD, the problems in Iraq, and the ensuing oil price volatility, has caused investors to curb some of their enthusiasm.

Why isn’t the carry trade gaining momentum?

The FX market is a bit of a conundrum at the moment, although market volatility is close to record lows, the carry trade has not thrived. For example, NZDJPY is still below the high from the end of March and AUDJPY, the bastion of the carry trade, is still range bound, although it is close to the top of its recent range. If AUDJPY and NZDJPY are to burst out of upcoming resistance levels, 96.51 and 89.93 respectively, we may need to see the oil price stabilise and geopolitical risks subside.

If this can happen, then the carry trade could be one of the big themes for the rest of this year. One pair that seems to be bucking the carry trade theme is EURGBP. We have already seen EURGBP fall to its lowest level for 18 months, as policy paths for the BOE and ECB diverge. Positioning data suggests that this pair may have further to fall, as the speculative FX community increased EURGBP shorts last week. The low from July 2012 at 0.7755 is in view in the medium-term. EURGBP seems to be shrugging off comments from Germany’s Finance Minister Schaeuble over the weekend, when he said that there was enough liquidity in the Eurozone system. He may be trying to placate the German banking lobby who have voiced their displeasure over the ECB’s cut in deposit rates, taking them into negative territory for the first time.

The NOK gets knocked by the Norges Bank

The importance of relative central bank stances could be seen in the performance of G10 FX last week. The CAD, AUD, NZD and GBP were the strongest performers, while the NOK was the weakest performer. The NOK was “knocked” by the Norges Bank who hinted that rates could be cut further at its meeting last week, while the CAD was boosted by stronger than expected CPI. This CPI release cemented Canada as the latest member of the “early risers” club. The UK, AUD and NZD have been in this club for a while, which has helped to push their currencies higher. The CAD gained permanent entry to the club last week, as the market began to suspect that the Bank of Canada may have to drop its dovish stance even in the face of the Fed’s Janet Yellen stubbornly ignoring inflation risks in the US.

Speculation over the BOC remains rife

At this stage we don’t think that the BOC will want to diverge too far from the Fed’s policy path, and even if Governor Poloz does drop his dovish bias, he won’t hint at rate rises any time soon. However, we don’t hear from Poloz and co. at the BOC until 16th July, which is a good three weeks away, and this gives the market plenty of scope to imagine a more hawkish BOC. Thus, in the absence of any major U-turns from the Fed, we think that we could see further downside in USDCAD, at least in the short term.

The technical picture: USDCAD

After further selling pressure this morning, this pair is now testing key support at 1.0731 – the 50% retracement of the September 2013 – March 2014 advance. We think that any recovery from this all important level will be short-lived, as investors unwind some of the sharp sell-off that we saw at the end of last week. Key resistance lies at 1.0892 – the June 18th high. A daily close below 1.0731 would indicate that a deeper sell off could be on the cards, with the next near term support at 1.0600 – the 61.8% Fib retracement of the same advance.

Takeaway:

• Relative central bank stances is king of the FX world right now.

• Although geopolitical risks and ensuing oil price volatility could keep interest in the carry trade limited.

• There could be further downside in EURGBP as investors are still keen to sell this cross.

• The Bank of Canada could be the newest member of the early risers club, after stronger than expected CPI from Canada.

• USDCAD is our one to watch, a daily close below 1.0731 – key support – could signal a deeper decline.