USD/CAD: Trading the Canada CPI Report

Trading the News: Canada Consumer Price Report

What’s Expected
Time of release:        11/18/2009 12:00 GMT, 07:00 EST
Primary Pair Impact :    USDCAD
Expected:         0.1%
Previous:         -0.9%

Impact the Canada Consumer Price Report has had on USDCAD over the last 2 months

September  Canada Consumer Price Report

Price pressures in Canada weakened for the fourth consecutive month in September to mark the longest slump since 1953, with the headline reading for inflation slipping 0.9% from the previous year. On the month, price held flat from August, while the core CPI slipped to an annual pace of 1.5% from 1.6%, and price pressures are likely to remain subdued going into the following year as the Bank of Canada projects inflation to hold below the 2% target until the second quarter of 2011. As a result, the central bank pledged to maintain the benchmark interest rate at the record low throughout the first half of 2010 in an effort to balance the risks for growth and inflation, and policy makers may take additional steps to shore up the economy as the marked appreciation in the Canadian dollar hampers the prospects for a sustainable recovery.

August Canada Consumer Price Report

Canada’s consumer prices fell more than economists expected in August as gasoline costs plunged. Inflation fell 0.8 percent in August from a year earlier, after July’s 0.9 percent drop that was the biggest since 1953, Statistics Canada said today in Ottawa. Forecasts were for  a 0.7 percent decline, based on the median of 20 estimates. The core rate of inflation fell to 1.6 percent from 1.8 percent in July as food costs fell 0.7% during the month. The BoC has already committed to keeping rates at their current record low 0.25% until mid-2010 unless inflation expectations rise. Prevailing risk aversion and a bearish “loonie” reaction to the data would have triggered a long USD/CAD trade. A lack of follow through would have limited profits to 25 pips.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the USD against the Canadian Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on USDCAD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the USD against the Canadian Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on USDCAD ahead of the data release.

How To Trade This Event Risk

Price pressures in Canada are expected to strengthen in October, with economists forecasting the consumer price index to expand at an annual pace of 0.1% from the previous month, and the data is likely to reinforce an improved outlook for the region as policy makers see the economy emerging from the recession in the third quarter. However, the monthly GDP reading showed economic activity unexpectedly contracted 0.1% in August after holding flat during the previous month, led by a 2.3% decline in energy outputs, and businesses may continue to scale back on production and employment throughout the remainder of the year in an effort to weather the downturn in global trade. Moreover, a report by Statistics Canada showed the economy shed 43.2K jobs in October, with the annual rate of unemployment rising to 8.6% from 8.4% in the previous month, while factory prices slipped 0.5% in September to exceed expectations for a 0.2% decline. In addition, manufacturing sales tumbled 2.1% in August to exceed expectations for a 1.6% decline, while wholesale demands slipped 1.4% in August, and the slump in private spending may continue to bear down on price growth as households face a weakening labor market paired with tightened lending standards. Nevertheless, the Bank of Canada held an improved outlook for the world’s eighth largest economy and said that a recovery is “under way,” and went onto say that  the risks to the economy are “roughly balanced.” However, the central bank warned that the marked appreciation in the exchange could “more than fully offset” the recent rebound in economic activity, and argued that the board retains “considerable flexibility” in its management of monetary policy as the board anticipate inflation to hold below the 2% target until the third quarter of 2011. Moreover, BoC Governor Mark Carney said that the central bank has “options” to temper the appreciation in the exchange rate during a speech in front of the Senate banking committee, which includes quantitative and credit easing, and noted that the “slack” in the economy is likely to keep price pressures subdued throughout the following year. In addition, Prime Minister Stephen Harper said that  the recovery remains “fragile,” and declared  that the nation is emerging from the economic downturn “only in a technical sense” as the rise in the Canadian dollar hampers the prospects for a sustainable recovery. As a result, a dismal CPI report is likely to drag on the exchange rate as investors weigh the outlook for future policy but nevertheless, as risk trends continue to dictate price action in the currency market, a rise in risk aversion could weigh on the loonie as the reserve currency benefits from safe-haven flows.

Trading the given event risk favors a bullish outlook for the Canadian dollar as market participants anticipate inflation to expand for the first time in five months, and price action following the CPI report could set the stage for a short dollar-loonie trade as policy makers project the economy to emerge from the recession. Therefore, if the annual rate of inflation increases 0.1% or greater in October, we need to see a  red, five-minute candle subsequent to the release to confirm a sell entry on two-lots of USD/CAD. Once these conditions are met, we will set our initial stop at the nearby swing high or a reasonable distance, and this risk will establish our first objective. Our second target will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in order to preserve our profits.

On the other hand, the marked appreciation in the exchange rate paired with the slump in the domestic economy is likely to weigh on inflation going into the following year, and price pressures are likely to remain subdued as policy makers see a risk for a protracted recovery. As a result, if the CPI contracts at an annual pace of 0.1% or greater, we will favor a bearish outlook for the Canadian dollar, and will utilize the same strategy for a long dollar-loonie trade as the short position laid out above, just in reverse.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com