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So long holidays – we hardly knew ye. Full participation is back in the currency markets this morning, with liquidity levels rising ahead of what is expected to be an eventful week. With non-manufacturing purchasing manager indices, Federal Reserve meeting minutes, English and European rate decisions, Chinese financing data, American non-farm payroll numbers, and Canadian unemployment levels all due to be released over the coming days, market participants are warily writing prenuptial agreements against their exposures. Hedgers should be doing the same.  

Commodity markets are a sea of red this morning, after the HSBC/Markit Chinese services purchasing manager index fell to a two year low for December. Investors are increasingly concerned that the seasonal inventory build is now over for the world’s second largest economy, meaning that demand for raw materials will weaken in the months to come.

The yen is stronger against the big dollar, benefitting from safe haven flows as well as a broader sense that the currency had fallen too far, too fast. A similar dynamic is putting a floor under the euro after last week’s extreme selloff – while the currency had unquestionably flown too close to the sun, many market participants feel that low liquidity conditions exacerbated the depth and scale of the correction, meaning that the unit is poised to mean-revert in the coming days.  

Positions on the greenback itself are more mixed however, with some traders expecting Wednesday’s Fed minutes to illustrate more dovish views on tapering than have been priced in thus far. There is also considerable uncertainty around the non-farm payrolls number due to land  on Friday, with the blockbuster results of the last two months expected to fade as the year begins.  

Weighed down by the Chinese data, Canadian dollars are trading with a weaker bias. The pair has established a clearly demarcated trading range over the past few weeks, with support building just below the 1.06 mark, while heavy resistance is increasingly evident on the 1.07 handle. These levels may be challenged  on Friday  however, when domestic employment numbers are expected to exhibit continued underperformance relative to the United States. In the event of a positive surprise, the high 1.05’s could briefly come into range for well-prepared hedgers, while a negative shock could provide the catalyst for a break through the low 1.07’s.

After last year’s gains, many market participants will want to spend the coming days in a retrenchment phase, skimming some of the froth off over-bought markets before investing in a more discerning manner. This portfolio rebalancing could temporarily reverse a number of trends. As asset managers rotate funds away from the larger developed economies into smaller export-focussed markets to take advantage of what is expected to be a stronger global economy, we wouldn’t be shocked to see the dollar lose ground – despite generally favourable fundamentals.  

As such, we would suggest that dollar buyers look to layer into positions over the coming weeks using limit orders to capitalize on small moves. Remember that in foreign exchange, there is little or no advantage to going all in at a single level – breaking transactions into smaller tranches and dripfeeding those into the market over time often generates superior results…

Further reading:

ISM Non Manufacturing PMI disappoints – dollar weaker

Important news expected in the first full week of 2014 Weekly overview (30.12.2013-03.01.2014)