At the July meeting the BoC confirmed market’s speculation that they will continue to scale back asset purchases by tapering with another C$1bln reduction per week. Even though the bank’s language and overall tone was in line with overall consensus, the reaction in the CAD suggests that some participants might have been expecting more from the bank in terms of a hawkish tilt. The bank also reiterated that there is particular uncertainty in their projections and stressed that the economic recovery requires extraordinary policy accommodation, which arguably is something the bulls wanted to see removed in the statement. It’s important though to keep in mind that positioning has seen a lot of the positives for the CAD already reflected in the price since the hawkish tilt in April, which means the downside we’re seeing could still be some unwind from the prior upside as the market will need more and more positives to keep the upside momentum going.
2. Commodity-linked currency with dependency on Oil exports
Oil staged a massive recovery after hitting rock bottom in 2020. The move higher has been driven by (1) (OPEC’s production cuts); (2) improving global economic outlook and improving oil demand outlook (vaccines and monetary and fiscal stimulus induced recoveries); (3) rising expectations (reflation). Even though further gains for Oil will arguably prove to be an uphill battle, the bias remains positive in the med-term as long as the current supportive factors and drivers remains intact, and as long as oil remains supported that should be supportive for the Petro-currencies like the CAD as well.
3. Developments surrounding the global risk outlook.
As a high-beta currency, CAD has benefited from the market’s improving risk outlook over recent months as participants moved out of safe-havens and into riskier, higher-yielding assets. As a pro-cyclical currency, the CAD enjoyed upside alongside other cyclical assets going into what majority of market participants think was an early post-recession recovery phase. As long as expectations for the global economy remains positive the overall positive outlook for risk sentiment should be supportive for the CAD in the med-term . Some participants have recently flagged that a lot of the CAD’s positives are arguably already reflected in the price, which does mean we want to be careful of possible stretched net-long positioning in the short-term.
JPY – FUNDAMENTAL BIAS: BEARISH
1. Safe-haven status and overall risk outlook
As a safe-haven currency, the market’s risk outlook is the primary driver of JPY. Economic data rarely proves market moving; and although expectations can prove highly market-moving in the short-term, safe-haven flows are typically the more dominant factor. The market’s overall risk tone has improved considerably following the pandemic with good news about successful vaccinations, and ongoing monetary and fiscal policy support paved the way for markets to expect a robust global economic recovery. Of course, there remains many uncertainties and many countries are continuing to fight virus waves, but as a whole the outlook has kept on improving over the past couple of months, which would expect safe-haven demand to diminish and result in a outlook for the JPY.
2. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares an inverse correlation to strong moves in yield differentials, more specifically in strong moves in US10Y . However, like most correlations, the strength of the inverse correlation between the JPY and US10Y is not perfect and will ebb and flow dependent on the type of market environment from a risk and cycle point of view. Even though the correlation was exceptionally strong from the start of the year, we have started to see some breakdown in the correlation over the past few weeks. However, after the FOMC’s recent communication has improved the outlook for the US Dollar we would expect the low yielders like the JPY to remain pressured against the greenback which could see a weaker correlation develop with US10Y and see a continued bias titled higher for the USDJPY .