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Guest Commentaries: Sudden Shift in “Risk on/Risk Off” Trading

Boris Schlossberg

Traditional correlations among commodity currencies including the Australian, New Zealand, and Canadian dollars are fading, leaving each currency to trade on its own merits in 2013.

One of the more interesting recent developments in the currency market has been the sharp price divergence among the commodity dollar bloc. For the longest time, the Australian, New Zealand, and Canadian dollars all traded in tandem, rising and falling with the vagaries of risk appetite. Amongst the three, the Australian dollar (AUD), with the largest yield in the G-20 universe, was always the leader of the pack, performing best when risk appetite was highest.

However, that dynamic has changed greatly as the boom driven by China's insatiable demand for iron ore and other hard commodities tapered off. As China curbs its massive capital spending plans, Australia finds itself with a bloated currency, challenging terms of trade and markedly slowing growth.

The latest Australian economic data has been worrisome, with retail sales contracting, housing demand declining, and manufacturing production still mired below the 50 boom/bust level. Although employment has held up relatively well, the gains in jobs have been temporary in nature, not permanent.

The slowdown in Australian economic growth has forced the Reserve Bank of Australia (RBA) to lower rates to the 3.00% level, and many market participants expect perhaps another 50 basis points of easing before the central bank is done.

Furthermore, Australian monetary and fiscal officials continue to comment on the strength of the Australian dollar, which remains above parity versus the US dollar. During the heyday of Chinese demand, high Australian exchange rates were not a barrier, as demand for raw goods remained unabated. However, now that Australia must seek different avenues for growth, the exchange becomes a serious competitive disadvantage, and there is no doubt that authorities would like to see it slide below parity.

For now, the Aussie has held above the 1.0250 support level, but it continues to make progressively lower highs as selling pressure remains on the unit. Therefore, a break below 1.0250 could open the path towards 1.0150 and possibly parity, especially if the RBA cuts rates, further diminishing the Aussie interest rate advantage in the process.

What’s Driving New Zealand Dollar Strength

Meanwhile, across the Tasman Sea, the New Zealand dollar (NZD) has been remarkably resilient as the demand for soft commodities like dairy and wheat remains buoyant, translating into much-better-than-expected economic performance. New Zealand PMI and retail sales data both surprised sharply to the upside, indicating the economic activity continues to improve. Furthermore, New Zealand officials remain unconcerned about the recent strength in the kiwi, with Prime Minister JohnKey even stating that consumers were better off with a stronger currency. Little wonder, then, that the kiwi has remained near its yearly highs versus the Aussie. The pair sees resistance at the .8500 level, but if it can break through with conviction, the kiwi could climb as high at .8700, further widening the gap between it and the Aussie.

Canadian Dollar Outlook in Jeopardy

Lastly, the Canadian dollar (CAD) has also shown signs of strain over the past month as a decidedly dovish Bank of Canada (BoC) and a series of disappointing data points have pushed the USDCAD pair above parity.

Despite the relatively strong growth in the US and oil at nearly $100 per barrel, the Canadian economy has not been able to benefit. Employment data saw surprising drop in jobs to -21.9K versus 4.5K expected, while manufacturing sales contracted -3.1% versus -0.4% eyed. If this week's retail sales prove to be a disappointment, the loonie could see even more selling, as any hope for more restrictive monetary policy will evaporate.

If Canadian officials, much like their Australian counterparts, seek a weaker currency, the Canadian dollar could continue its decline against its North American neighbor. For USDCAD, the 1.01000 level remains the key resistance point. A break higher there could open up the path towards 1.0300 as the quarter proceeds.

For now, its clear that the days of risk-on/risk-off” trading are over, and the each commodity currency will trade on its own dynamics in 2013.

By Boris Schlossberg of BK Asset Management

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