By Michael O’Neill

Summer is not even officially over, but the nights are getting colder, and the leaves are starting to turn.  Black bears and Grizzly’s have had their fill of berries, salmon, and iterant hikers, and are looking forward to a long winter’s nap.

It is not so different for USDCAD traders in this coronavirus summer of 2020.  The currency pair started sliding on the May long weekend and continued virtually unopposed into September.  There is a litany of reasons for the sell-off, and none of them has to do with domestic issues.

Federal Reserve Chair Jerome Powell and his colleagues on the Federal Open Market Committee triggered a US dollar sell-off with their aggressive response to the COVID-19 pandemic.  They slashed the overnight Fed Funds rate to 0.25% in the first two weeks of March, while injecting massive amounts of liquidity into financial markets, nipping a global financial crisis in the bud.

Although the Fed’s actions could not cure the coronavirus, they managed to heal a crippled Wall Street, and turn it into a world-record-breaking sprinter.  Usain Bolt can only wish to move as fast.

Soaring US stock markets and a “we-are saved” mentality sparked a move into so-called “risk-on currencies” which included the Canadian dollar.  Saudi Arabia spurred the commodity currency rally when it ended its price war with Russia. 

The US budget deficit blew out to $3.0 trillion while the Canadian government budget deficit soared from $25 billion to over $350 billion.

The European Union was late to the party.  It took EU officials from May 19 to July 20 to adopt a €750 billion fiscal stimulus plan Pandemic Emergency Purchasing Plan, another name for a Quantitative Easing, initially proposed by France and Germany.  That was the news that put US dollar bears into the driver’s seat.

Summer markets are notable for inferior liquidity, especially in August.  This year was no different.  Equity and FX volumes were low and exaggerated moves.  The S&P rose over 7% in August, which is rather impressive considering its 90-year average annualized return is 9.8%.  The rally also triggered a wave of US dollar selling noticeably against CAD, and GBP, due to month-end portfolio rebalancing requirements.

USDCAD sank 11.0% from peak to trough between the end of May and the beginning of December. The set-up is eerily like the January to May price action in 2018.

If history repeats itself, USDCAD may rally to the 1.3600 area by the end of November.

There are plenty of reasons to be own USDCAD in the final three months of the year, including seasonal demand.  The domestic currency comes under selling pressure as the subsidiaries of US corporations repatriate profits heading into year-end.  The following chart shows that USDCAD rallied in October and November, 63% of the time between 1998- and 2018.  It was true in 2019 as well.

Source:  Vantage Point

External forces dictated USDCAD price action for most of the year.  That will not change in the next four months.  The US dollar is the safe-haven currency of choice in times of trouble, and troubling times are brewing.

China is becoming more belligerent daily.  The nation is embroiled in controversies with Australia, India, Taiwan, Japan, Philippines, Vietnam, Canada and of course the USA. Any escalation of tensions would drive demand for US dollars through the roof.

Wall Street likes to meltdown in the fall.  Six of the ten largest declines in the Dow Jones Industrial Average since 1987, occurred in September and October.  You would be hard-pressed to find any knowledgeable equity trader describe the current market as anything but “frothy.” Take Apple, for instance.   September 2, Barbara Kollmeyer of MarketWatch reported that Apple’s market cap of $2.3 trillion exceeded the value of the “entire market capitalization of the stocks FTSE 100 Index.” The major Wall Street indexes are making new record highs daily.

Traders are blissfully ignoring rising geopolitical tensions and US political risks.

The US election is a powder keg waiting to blow.  President Trump is already blaming his loss on rigged balloting due to mail-in voting, even though the election has not even started.  Former President, Bill Clinton, warned yesterday that President Trump would not accept defeat and scheme to keep control of the White House.  Election drama could be the catalyst for a nasty equity market sell-off and boost the US dollar due to safe-haven demand.

USDCAD bears feasted for the past four months and will be content to sleep off the meal until year-end but will likely wake up with indigestion.