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Foreign exchange markets are in a consolidative mood this morning, with traders positioning ahead of a week that will be light on economic data and heavy on earnings releases.  US bourses are closed for Martin Luther King Day, meaning that trading conditions are tight and price movements highly erratic.  With more than 60 S&P 500 companies scheduled to report results in the coming days and equities trading at historic highs, many participants are wary of disappointment – and are standing by the exit signs in case a correction begins.

A package of Chinese economic data released overnight is helping to support sentiment, helping commodities and the Australian dollar to post small gains. China’s gross domestic product growth slowed to 7.7% in the last quarter, slightly beating expectations, while retail sales rose by 13.6% and industrial output expanded by 9.7%. This has helped to dampen Sino-skepticism in the broader markets, but concern about credit conditions remains acute.  

The euro is on the defensive, driven downward by speculation that the European Central Bank is preparing to add liquidity to the financial system in an effort to offset the rise in interbank lending rates that has occurred over the past month.  Peripheral debt markets gained support overnight after Ireland received a ratings upgrade, but this did little to reverse the selling – the common currency is trading near a six-week low. 1.3500 has become the equilibrium point for trading activity, with participants stepping in to sell the common currency when it moves too far, and others buying when it falls too low.  

Canada:

Renowned value investor and mentor to Warren Buffett, Benjamin Graham once said “in the short run, the market is a voting machine but in the long run, it is a weighing machine”. It appears that the voting phase is over for the Canadian dollar.  

After years in which investors voted for the loonie despite deteriorating competitiveness levels, economic fundamentals are now weighing on the exchange rate. Over the past month, the currency has fallen by almost three percent – the weakest performance among the majors, and among the worst in the world.  

In the coming days, the scales are likely to tip further as a series of events provide traders with deeper insight into the Canadian dollar’s direction. November  manufacturing sales, wholesale trade, and retail sales numbers will be released, along with December inflation data. While some of this data is likely to boost economic optimism, any lasting effect will be dwarfed by the Bank of Canada announcement due at  2pm on Wednesday.  

Many traders expect to see Governor Poloz shift the central bank onto an easing stance, widening the gap further between himself and his predecessor. After Mark Carney’s focus on financial stability at the expense of the country’s export sector, Mr. Poloz appears to be working toward an economic rebalancing. After dropping language about rate hikes in October, observers believe that he will now signal the need for lower benchmark yields. If this is the case, there will be little to stop the currency from blowing through the 1.10 mark on the way toward 1.12. Traders with short positions are rubbing their hands together in anticipation.  

We aren’t so certain. Although Mr. Poloz has unquestionably been influenced by his time with Export Development Canada, he is still a central banker at heart. Without strong and persistent evidence that the domestic economy is  deteriorating, it seems likely that any tilt toward dovishness will be extremely subtle.  

As such, we would caution market participants to tread lightly. The risk/reward ratio is clearly biased toward the downside on the Canadian dollar, but nothing is a foregone conclusion in the foreign exchange markets – a short-term correction remains a strong possibility.  

Further reading:

EUR/USD Jan. 20 – Escapes from low ground

AUDUSD: Deeper weakness triggered after losing key support