Forex Investment and Currency Trading

• Although USD/CAD has broken bullishly out of its eight month trading range, the near-term upside is limited from an interest rate perspective. A weaker CAD removes an important factor that had helped keep Canadian inflationary pressures under control. With monetary policy already stimulative, the BoC is unlikely to corroborate market expectations of at least one rate cut by year end.
• BoC is likely to disappoint the market by failing to corroborate rate cut expectations, as the BoC already considers policy to be accommodative. This will provide some resistance to USD/CAD rallies from the interest rate perspective.
• CAD, the BoC’s inflation fighting co-pilot for the past few years, has abandoned ship. USD/CAD
  has declined by 15.6% since 6 November 2007, easing some of the intense pressure on the
  Canadian factory and posing an upside risk to the Canadian/US finished goods factory price ratio.

GDP rebound expected, albeit only moderately
CAD is set to outperform the crosses during the remainder of the year as the ex-North American world is exhibiting increasing signs of trouble. While the risk of a technical recession in economies such as Germany, France, UK, Japan and New Zealand looms large, Canada’s economy is expected to
rebound squashing any talks of a technical recession. However, the recovery in H2 is expected to be painfully slow, with overall growth still well below potential of 2.75%. However, in relative terms, the Canadian economy would look quite stellar. The need to cut interest rates would thus also be much less pressing in Canada than in, for example, the UK and New Zealand.

Inflation risk in China subsiding
China’s economic growth, commodity prices and commodity base currencies are closely intertwined. Although weakness in Chinese export markets continue to pose a serious downside risk to the economy, inflation risks are subsiding. Inflation has been declining steadily since peaking at a 12-year high of 8.7% y/y in February 2008. The decline is opening the way for the PBoC to adopt a wait-and-see approach after a period of monetary tightening. Growth in post-Olympic China will likely not be allowed to fall far below 10%, limiting meaningful sell-offs in commodities and commodity-based currencies.

USD/CAD Pulls Back, But Backdrop Still Bullish
USD/CAD pulled back from overbought extremes, but has not come close to defying the bullish breakout above 1.0343. Thus pullbacks still represent medium-term opportunities to buy USD/CAD for a retest of 1.0677 and the August 2007’s 1.0862. Short-term studies are under keen consideration for the near-term direction on USD/CAD. The sell off below 1.0566 and the break below 1.0496 confirm that a short-term top is in place. The 1.0397-to-1.0413 area is key to the short-term performance. A break lower would further entrench the recent retracement. However, the backdrop is more conducive to this range providing an opportunity to buy USD/CAD for an eventual move back toward 1.0566 consistent with the medium term bullish outlook.