Trend taking U-turn as major currencies struggling while CAD gaining heights

Greece is currently negotiating the details of an emergency joint rescue package from the euro zone and International Monetary Fund.

The Greek government has said it wants to reduce the deficit to 5.6% of GDP in 2011 and 2.8% of GDP in 2012. But spending cutbacks measures being introduced by Athens to restore its finances are being resisted. Yesterday tens of thousands of Greek civil servants staged a 24-hour strike in protest against the austerity measures.
The Bank of Canada yesterday continued to keep financial markets guessing about when policy rate increases may begin, but said their time has come. Likely dates are June 1st or July 20th for the first of a series of increases.

Canada’s dollar traded near a 22- month high against its US counterpart in the forex online market as the central bank signaled an increase in interest rates and reiterated that the need for economic stimulus is fading. The currency hit a high of CAD 0.99606 before dropping back to close just below parity at CAD 1.00061.

The Bank only provided detail in a Monetary Policy Report to outlines given Tuesday when it maintained the year-long rock-bottom overnight rate target at 0.25%. It said the need for such extraordinary stimulus is over and it is time "to begin to lessen the degree of monetary stimulus." However, the timing and size of rate increases "will depend on the outlook for economic activity and inflation." And here, on economic activity and recovery from recession, the Report is laced through with cautions.

Inflation is expected to remain anchored at around the 2% target through 2012, with the Bank evidently little concerned about it. Looking at growth, though there was a strong 5.8% recovery in the first quarter of this year, and 3.8% expected GDP increase in the present quarter, this recovery is "front-loaded," the Bank says. Growth will diminish to 3.5% in the second half and more rapidly in 2011, down to just +1.9% in the two final quarters of next year.

From now on, Canadian growth "will revert more quickly to trend," in the Bank's assessment. From the present second quarter this year through all of 2011, growth slows because policy stimulus measures had brought forward "considerably more expenditures" late last year and early this year than expected. Moreover, the Bank expects "a somewhat weaker outlook for US economic growth starting in the second half of 2010." Another drag is "the higher assumed level for the Canadian dollar."
The Bank bases its assessments in part on a Canadian dollar averaging 99 cents against the US dollar over its projection period (through 2012). The Canadian dollar was at parity with the US dollar Wednesday.

On an average annual basis, Canadian GDP is expected by the Bank to grow by 3.7% this year, against just 2.9% expected in the January Monetary Policy Report. Then, growth slows gradually to 3.1% in 2011 (3.5% expected last January), and down to 1.9% in 2012.

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Chart analysis USDCAD

Equity Updates

Equities have taken a beating overnight after recently doing an amazing job of showing resilience lately in the face of some very ugly data, but it appears that last nights bailout package failure is serving as a reality check. Note the weekly initial jobless claims number out of the US yesterday, which, at 573k shows an alarming further acceleration in job losses from already elevated levels. Today we have US Retail Sales and the news will inevitably be bad there (expectations already looking for only slightly better than last month's near record drop). Seems like the complacency in the market has been shaken a bit here and we risk larger moves again in currency-land - beware the volatility and stay careful out there.

Charts: USDCAD

USDCAD: CAD could be at the epicenter of market activity today due to CAD's sensitivity to the US auto industry. Yesterday saw the technical capitulation below the very clear 1.2450 line of support, but now we've already back above that level again this morning. We'd still like to see the pair close today back above the 1.2550 level to call a full reversal here, but the way winds are blowing at the moment, we may be setting up for a test of 1.3000+ here soon if the mood across markets remains sour. Energy prices are another variable worth watching in this equation.

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Current Moves in Forex Market

US-China talks yield little.

The US-China economic dialog talks seemed to have mostly centered on shoring up the stability of the financial system, an understandable worry on China's part after all of this turmoil, considering its enormous holdings of US debt. The talks ended with no substantive announcement on Chinese currency. Instead, measures were announced to allow freer access by Chinese banks in the US market and various other "agreements" were likely on electricity generation, environmental issues, etc.. The talks were unlikely to lead to much substantive with Paulson as the lame duck US treasury secretary. We will have to wait for Obama and Geithner and company to see whether the Strategic Dialog framework continues and how combative the president-elect remains on the Chinese currency, after using it as a populist issue in the campaign. Will the Chinese continue to keep the Yuan in this range just below 7.00, or will they allow some weakening of the Yuan to test the Obama team's resolve ahead of inauguration? This is a huge issue.

US employment report

Another fearsome US employment report is on tap for today, as the US economy may have lost more jobs in one month than at any time since the early 1980's. Expectations for the Change in non-farm payrolls are running for a drop of well over 300k. The unemployment rate is expected to jump again, this time to 6.8%. There is nothing to suggest any chance of upside surprise on this data. The question is how dependent the USD is on economic data after yesterday's attempt at a reversal.

CAD under pressure

CAD fell sharply across the board yesterday on another wave of capitulation in crude oil prices and on developments in Canadian politics: as PM Harper convinced the Governor General to suspend parliament until late January in a bid to save his government from a confidence vote and attempt to refocus the legislature on the budget. This was an unprecedented move. Also, the bottom fell out of the Canadian Ivey PMI yesterday, which registered its lowest level in the near 10-year history of the survey. It would appear that a test of the 1.3000 level in USDCAD may be in the works soon.

Market action

Equities sold off sharply later in the US session, and this took the JPY stronger again after the short squeeze earlier in the day had driven the JPY sharply weaker. These markets are indeed treacherous as directional signals last mere minutes before reversing course. CHF also woke up and got back on its old safe haven horse briefly, and EURCHF dipped to test its 21-day moving average again before easing back higher overnight as the equity sell-off failed to turn into a rout. We really need a breakout of some kind that holds to get a better directional indicator.

The parabolic drop in US yields at the long end is due to the clear intention by the Fed and Treasury to try to control the long end of the government yield curve, in an effort to shore up the housing market. The dramatic fall in mortgage rates (due to outright purchase of GSE mortgage debt announced previously and the indication that the Fed will likely monetize debt down the road) has seen a boom in refinancings. US yields are plummeting relative even to European yields all along the curve, and thus not really providing any support for the USD in terms of interest rate differentials. This action looks downright panicky and unsustainable.

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