FxWirePro: Are you against US dollar or commodity-driven currencies? Which is more vulnerable?

Although the crude oil prices bounced back a bit yesterday but even so, softer commodities coming after softer Chinese PMIs have seen Australian equities and the AUD fall overnight in markets thinned-out by holidays in Hong Kong and Tokyo.

In the very long run, currencies still tend to re-convergence with purchasing power parity (PPP), either because relative prices adjust or because of the currency moves. The OECD estimates that the USDCAD PPP exchange rate is around 1.24, quite a bit higher than my simple ‘latte’ index PPP index but also quite a bit below current levels. CAD has tracked oil prices and relative yields in recent years and on oil prices look to have over-reacted to the most recent move.

Overnight moves were dominated by the reaction to a slower pace of iPhone (and iPad) sales in the US, to falling commodity (oil, iron ore and copper) prices, and the front-page headline in the FT – “Brussels hosts gross Brexit ‘bill’ to EUR 100bn.

The US news, which includes a generally soft feel to recent data, has taken 10year Note yields back below 2.30% ahead of the FOMC meeting (announcement due at 1800 GMT) and renewed concerns about Brexit have put sterling on the back foot, at least for now.

Yesterday was the fifth time Brent prices have traded under USD 50/bbl in the last two months and the fifth time when the promptly bounced, though current spot at $50.24 isn’t exactly encouraging. A clear break would sour sentiment significantly. In FX terms, the vulnerable currencies are NOK and CAD in G10, RUB and COP (much more than MXN of late) in EM.

Uphold shorts in NOKSEK as it seems a pretty good trade, just in case as for USDCAD, a break lower could see the major technical resistance at 1.3840 tested, and we don’t encourage shorts in USDCAD in the blind hope that will hold. A break lower could see us go as far as 1.40, at which time valuation, both against the US dollar but also against AUD and NZD, is pretty irresistible.

Elsewhere, when USDCAD was last above 1.37, Brent was USD 15/bbl cheaper. You can also track the under-performance of the CAD against PPP by looking at it relative to yield spreads. Higher breakeven oil prices for Canadian oil sands than for US shale have seen Canada suffer more than the US from low prices, and stress in the sub-prime mortgage market is hurting sentiment. As long as that translates into widening US/Canadian yield differentials, hence, we loathe diving into CAD longs.