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East is East and West is West – but the twain met last week. A spike in Chinese interbank rates triggered a retreat from growth-sensitive assets around the world, helping to skim the froth off a secular rally that sent many equity indices to historical highs over the last month. Investors sold commodity-linked currencies like the Aussie and Canadian dollar in the expectation that raw material demand would slow as policymakers in the world’s second largest economy tightened monetary policy.

This overreaction began to dissipate this morning, driving a recovery across a number of markets. Traders have come to the conclusion that the government is unlikely to decisively reduce liquidity until after the ruling Party holds its Third Plenary in November, meaning that last week’s spike was more than likely driven by seasonal funding stress rather than a concerted policy decision. The Aussie and Kiwi have recovered some ground, while the commodity complex is up slightly.

The dollar is trading with a weaker bias after the University of Michigan released sharply weaker consumer sentiment numbers for early October, spurring bets that the Federal Reserve would keep the stimulus flowing. West Texas crude is trading around the $97 handle, while equity bourses are challenging six-year highs.  

Market participants are now shifting stance, looking to position ahead of a number of important datapoints in the days to come. The festivities will starttomorrow  morning, when US consumer confidence numbers are released for early October, providing investors with an (admittedly incomplete) view into the state of the world’s largest economy ahead of the government shutdown. The Federal Reserve will then drop its latest interest rate decision on the markets  on Wednesday  afternoon, likely to confirm what most players already suspect – that it will keep the monetary stimulus flowing for several months yet.

Despite a generalized improvement in risk sentiment, the Canadian dollar has failed to gain traction thus far, weighed down in the aftermath of last week’s bearish tilt by the Bank of Canada. As expected, we have broken through the 1.04 mark and traders now have their sights set on the 1.05 target. With Wednesday’s Federal Reserve announcement unlikely to provide investors with anything more positive than what has already been priced in, and the odds against a positive surprise from Thursday’s September GDP number, we may be looking at the catalysts required for a move further down.

As such, dollar sellers would be wise to consider strategies that provide participation – instruments like currency options or tactics such as trailing limit orders should outperform in this environment. For dollar buyers, it is absolutely crucial that risk thresholds be established. Catching falling knives can be painful – and if the loonie continues to fall, importers may find themselves forced to try anyway”¦

Further reading:

EURJPY Bullish, Targets Further Upside

EUR/USD Oct. 28 – Little Movement Ahead of US Housing Data