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NZD/USD and USD/CAD Spread: Trading Opportunity
11/20/2010 - Click to Enlarge
Today we looked at all the currency pairs to find a trading opportunity for next week, the biggest spread that fit our technical/fundamental analysis outlook is NZD/USD and USD/CAD. How we are planning to trade this spread is to short NZD/USD while going long on USD/CAD. We are looking for the spread to meet around 1.25% in which we will liquidate the trades. We believe this set up has a good risk to reward ratio for the following reasons:
- NZD is coming off a fresh year high
- New Zealand’s economy is being negatively affected by the stronger NZD and it is starting to show in the economic data
- Canadian economy is benefiting from higher oil prices, but is susceptible to a slowdown in the US economy
- USD/CAD is near its lows and consequently we believe has more potential to rally.
- In general the US dollar is weak across the board and last week it was able to recover some of those losses
As always, keep contract sizes relative to account balance and this trade set up could take a week to complete.
FXIBonline Third Quarter Report 2010
In the third quarter we saw the dollar sell off across the board, due to the Federal Reserve board being bearish on the US economy and considering more Quantitative Easing towards the end of the year if need be. We do not foresee the Fed needing to institute more QE because we believe this summer was a soft patch in the economic recovery and will strengthen going into the fourth quarter. The US dollar has recently declined to a six month low against the Euro, the stronger Euro is already negatively impacting smaller European counties such as Greece and Ireland that actually need the Euro to depreciate to remain competitive and finance their debt. It is also interesting to note that US dollar shorts have hit a high not seen since mid-2008. In mid-2008, the EUR/USD was trading at 1.60 and eventually sold off to 1.23 as traders and asset managers reduced their dollar short positions. A benefit of the weaker dollar is it will help our exports creating a positive impact on our economic recovery. The weaker dollar will act as a mini “stimulus” and should help the manufacturing sector which has been leading the recovery. A recent report by Bloomberg utilizing a purchasing power basis estimated that the Australian dollar was overvalued by as much as 67%. Not only does a strong Australian Dollar have a negative impact on the Australian economy, but it means that at some point Australia will need to take steps to curb the strength of their currency to prevent deflation.
Commodities
This past quarter we saw commodities prices at record highs. Wheat hit 815.50 a bushel and currently is trading around 700, up almost 67 percent from its low in early June of 474. Corn hit a high of 536 from its yearly low of around 356 also established in June. This price action was prevalent throughout the commodity sector during the third quarter, including gold and silver which are enjoying all time highs. What is causing this? Russia was an unfortunate recipient of poor weather this year resulting in damaged crops with the consequence being a cap on their commodities exports. Australia has also struggled with production given their weather patterns however, the U.S. has managed to remain fairly consistent because of our technological advances such as irrigation and types of seed. One exception to this quarter’s commodity rally is oil. Oil has not enjoyed this surge in pricing primarily due to the underlying economic factors surround global expansion. Not even the massive oil leak in the Gulf of Mexico was able to push prices significantly higher. These kind of price increases remain unsustainable in the short term given that the US still has a 9.5% unemployment rate. Many market participants including us at FXIB compare this current situation to that of oil in the summer of 2007. When prices of commodities rise this high this fast the shock to the global system hits in waves, these waves cause mini bubbles in prices not only for food producers and consumers but in how banks structure loans and lines of credit based on overcapitalized hard assets. As a result of these bubbles when markets do re-align themselves, (and they will as we saw with oil) you are left with over priced bonds, loans and market valuations that will not be able to be sustained at these historical price levels. What does this mean for the average investor? Be careful buying commodities or commodity tied investments at these prices. Based on our research, gold is not an effective hedge against inflation, but is rather more effective as a hedge against the debasing of the US dollar. If the US Federal Reserve does start more Quantitative Easing, commodities could rally further however, we do not believe the Fed will need to do another round of Quantitative Easing.
Fourth Quarter Outlook
Given this backdrop, we expect commodities and commodity related investments to sell off in the fourth quarter and possibly into the first quarter of next year. We expect the US dollar to recovery some if not all of its recent losses and will keep a close eye on the US Federal Reserve statements as to any clues or direction they may take in regards to Quantitative Easing. We are also keeping an eye on the Chinese Currency Bill that just recently passed the US House of Representatives. The bill labels China as a currency manipulator and gives US companies the ability to levy charges on Chinese imports. If this bill is signed into law, we should see AUD/USD sell off as a proxy for the USD/CNY exchange rate. This bill is the toughest response by the US in regards to China’s polices. A currency war is already raging behind the scenes in which each country is trying to devalue their currency to stimulate economic growth. (what we call a race to the bottom). We do expect volatility to remain about the same, and we will continue to keep on eye on the leading economic indicators for the US economy.
This Week in Review 09/19/10 – 09/24/10
This week we saw the dollar sell off across the board, primarily due to the Fed’s statement that they could start up the printing presses towards end of the year to boost the recovery. We do believe that the market over-reacted to the statement since the Fed only said it was an option available and they had not yet reached a final conclusion on more QE. The one benefit of a weak dollar is that it makes our goods cheaper overseas and will help our economic recovery, kind of a mini stimulus itself. Eventually countries that export to the US will need to weaken their currencies to prevent growth from stagnating or creating deflation, so we do foresee currencies like AUD, EUR, CAD, and JPY weakening towards end of the year.
EUR/USD – This week the pair rallied strongly overcoming resistance at 1.3310 and closing at its highs up at 1.3490. At this point, we do not see resistance till 1.3810. Support lies down around 1.3300 on any pull backs.
GBP/USD – This pair had another good week and finally managed to break out of its range bound trading zone for the last few weeks. Next resistance lies up at 1.60 and support lies down around 1.5675.
USD/CHF – This pair had another bad week that saw it slide as low as .9779, but closes at .9836. The all time low for USD/CHF was established during the GFC (Global Financial Crisis) in which it fell to .9636. At this time we are continuing to buy USD/CHF on dips as we expect a strong short covering rally once a bottom is put in place.
USD/JPY – This week the pair gave back all of its gains from last week. It almost closes at the level where BoJ intervened last week. It closes at 84.20 from opening at a high of 85.80. It seems that the BoJ intervention from last week was largely unsuccessfully. We feel that the USD/JPY is too low to comfortably short it, but at the same time we don’t want to go long cause we do not know when this pair will finally bottom out.
AUD/USD – For the second week in a row this pair has had another solid performance against the USD. It overcame .9410 resistance early in the week and closes near its high at .9591. The all time record high for AUD/USD is at .9849 and if it manages to break .9600 then we could see .9800. Support lies at .9385 for pullbacks.
USD/CAD – This pair did not benefit as much from the weaker dollar like AUD did, however it still ends marginally lower then it opened. It closes this week at 1.0243. China was a stronger buyer down around 1.0220 earlier this week limiting the Canadian dollar gains. USD/CAD still remains range bound between 1.0100 and 1.0650. Resistance lies up at 1.0385 and support down around 1.0180.
NZD/USD – This pair did rally along with AUD, but gains were muted. It closes the week at .7340. Resistance lies up at .7420 and support lies down around .7250.
Update on Forex Inter-Market Correlations
As the third quarter comes to a close, it’s necessary for us to update our correlations for each currency pair that we trade. This is a integral part of how we manage each investors portfolio to balance the account’s exposure. Utilizing correlations to trade the forex is a complicated trading strategy and correlations can and do break down over time. For our analysis here, we will only examine the major currencies that we trade.
Currency Cross Correlations: (all correlations calculated with a three month time frame) To eliminate redundancies we have only done one currency cross correlation analysis. (ie: the correlation between EUR/USD vs GBP/USD and GBP/USD vs EUR/USD is the same.)
EURO Crosses
EUR/USD vs USD/CHF- Correlation is -.83. This is a little weaker then expected, but they still have a strong negative correlation. This correlation is the most easiest for new traders to pick up on due to its consistency.
EUR/USD vs GBP/USD – Correlation is +.91. Out of all the major currency pairs, this is the strongest correlation for EUR/USD. This a stronger correlation then we expected.
EUR/USD vs AUD/USD – Correlation is +.85
EUR/USD vs NZD/USD – Correlation is +.86
EUR/USD vs USD/CAD – Correlation is -.42
EUR/USD vs USD/JPY – Correlation is -.77
AUD Crosses
AUD/USD vs USD/CHF – Correlation is -.86
AUD/USD vs USD/CAD – Correlation is -.57. This is a little weaker then expected, but still shows that as AUD/USD goes up, USD/CAD has a high probability that it will go down.
AUD/USD vs NZD/USD – Correlation is +.91. This is the strongest correlation for AUD/USD out of all the other major pairs. This strong correlation does fall under our expectations, and probably the second easiest correlation for new traders to pick up on.
AUD/USD vs GBP/USD – Correlation is +.84
AUD/USD vs USD/JPY – Correlation is -.80
CHF Crosses
USD/CHF vs NZD/USD – Correlation is -.81
USD/CHF vs USD/CAD – Correlation is +.22
USD/CHF vs GBP/USD – Correlation is -.88
USD/CHF vs USD/JPY – Correlations is +.93. This has surprised us greatly given that historically these two currency crosses do not have a strong correlation. This correlation is the strongest for the CHF and JPY crosses.
CAD Crosses
USD/CAD vs USD/JPY – Correlation is +.07, we were surprised to find that this comparison has the lowest correlation of all the pairs.
USD/CAD vs GBP/USD – Correlation is -.38
USD/CAD vs NZD/USD – Correlation is -.68
JPY Crosses
USD/JPY vs GBP/USD – Correlation is -.85
USD/JPY vs NZD/USD – Correlation is -.68
NZD Crosses
NZD/USD vs GBP/USD – Correlation is +.84
This Week In Review: 09/12/10 – 09/17/10
EUR/USD – This week the cross closes higher then the close of last week at 1.3047. We did have a pretty volatile week, in which we saw EUR/USD rally to a high of 1.3158. We believe this pair will remain range bound between 1.2600 and 1.3200 over the next few trading days. A break above or below either level should see continuation of that move.
GBP/USD – This pair also ends higher against the dollar, it closed out last week at 1.5355 and this week it closes at 1.5629. Trading range was from 1.5347 – 1.5728. GBP/USD is still above the bullish trend line so it could see further gains, but resistance at 1.60 could cap any rallies. We have a slightly bullish bias on GBP/USD at this point in time. A close below the bullish trend line at 1.5380 would probably see increase selling while a break below 1.5300 could open the door to 1.5100.
USD/JPY – This cross has been the story of the week with the Bank of Japan intervening to prop up its currency. And it is on that note that USD/JPY finishes this week extremely higher then it opened up at. USD/JPY is the only currency cross this week to post a very strong dollar rally. As stated in our previous post, we expect USD/JPY to reach 88.00 – 90.00 before the Bank of Japan stops intervening. If short this pair, it is recommend to use a tight stop loss.
AUD/USD – Ends this week at .9360 and closes right at the bullish trend line support. A break below .9330 could see selling pressure increase. Aud also failed to fill the 30pip gap from last weekend, so that could act as a gravitational force for price in the coming week. We expect the RBA to remain on alert and to sell AUD above .9400, we believe this is the primary reason as to why gains past .94 have been limited and this cross could remain a volatile pair.
NZD/USD – Tagged along with AUD, but ends the week lower against the dollar at .7256. We not only had one trading opportunity on this pair, but two. Both trades ended up closing out in profit and at this point we have a neutral outlook. It is still above the bullish trend line, but we will look to go long if it reaches .7150 (just above the bullish trend line) And of course we’ll look to re-short the cross if it rallies up to .7350, resistance at .7400 has been capping rallies so far.
USD/CAD – This pair ends the week exactly were it opened, at 1.0331. The cross tested the bearish trend line today and closes right at it. USD/CAD has been range bound between 1.0100 and 1.0675 over the last few weeks. We expect this range to continue for the next few days. We have a slightly more bullish outlook on this cross and will look to go long once we get a confirmation that the downtrend has broken.
USD/CHF – This is a pair we have been watching for awhile now, just when you think a bottom is in place, it sells off. Despite the probe lower to .9928, this cross manages to close above parity at 1.0096. It does close lower then it opened at, reversing all of last weeks gains. 1.0275 is resistance on the way up, and the cross will now need to close above 1.0280 for us to consider a bottom has been put in place. Traders are still heavily short CHF crosses and we think that it is highly susceptible to a short covering rally. One interesting note is that the Bank of Japan intervention in USD/JPY helped propel USD/CHF back above parity, whether that can be attributed to traders unwinding short positions on concerns about a possible SNB intervention or just BoJ buying up a lot of dollars is hard to say.
Hope everyone had a good week!
NZD/USD Trading Opportunity
09/13/10 - Click to Enlarge
As mentioned yesterday, we would keep on the look out for a short trading opportunity to short NZD/USD. We feel that this trade has a good risk to reward ratio. We entered short at .7344 with initial profit target down at .7263 and the stop loss at .7400. We went short based on the resistance at .7357 and price starting to bounce down. For people who are more inclined to wait for a stronger confirmation (that price will continue to go down) then I suggest waiting till the bullish trend line is broken. At this point in time we see more potential for a sell off then a continued rally.
UPDATE – 09/14/10
09/14/10 - Click to Enlarge
The NZD/USD sold off pretty quick yesterday in the late afternoon due to weaker then expected retail sales. Eventually it did break the bullish trend line where it then consolidated its move. Overnight, European traders continued to dump NZD for the USD. You can see where price reached a low at .7267 just above our profit target. We believe the stronger US retail sales data this morning will continue to support the USD against NZD and will keep the trade open. But just in case risk returns to this pair, we have moved our stop to .7310 to protect our profits. .7310 is above the bullish trend lines as well as the moving averages. If the moving averages give a sell signal, then price could reach our profit target.
Good luck today!
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