USD/CAD: Trading the Canadian 2Q GDP Report

Trading the News: Canada 2Q GDP

Why Is This Event Important:

However, the Bank of Canada lowered its 2010-11 growth forecast last month after rising the benchmark interest rate to 0.75%% and said “any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments” as policy makers expect the economy to operate below full capacity throughout the following year.

What’s Expected:

Time of release:08/31/2010 12:30 GMT, 8:30 EST

Primary Pair Impact :USDCAD

Expected: 2.5%

Previous: 6.1%

Will This Be Market Moving (Scenarios):

The 2Q GDP report is forecasted to show the growth rate increasing at an annualized pace of 2.5% after expanding 6.1% during the first three-months of the year, and the economic recovery may gather pace in the second-half of the year private sector activity improves. However, the rebound in economic activity may taper off going forward as businesses keep a lid on production and employment, and the central bank may adopt a wait-and-see approach in September as the U.S., Canada’s largest trading partner, continues to face a risk for a protracted recovery.

The Upside

As building activity in Canada gathers pace, with businesses continuing to increase their stockpiles of unsold goods, conditions may improve further throughout the year as policy maker’s talk down the risks for a double-dip recession. Accordingly, the 2Q GDP reading may top market expectations and lead the BoC to normalize monetary policy further this year, which could lead the USD/CAD to close the gap from the 200-Day SMA at 1.0386.

The Downside

However, the unexpected drop in payrolls paired with the slower pace of private consumption in Canada suggests the economic expansion is tempering off as the BoC lifts borrowing costs off the record-low, and businesses may look to keep a lid on production and employment in the second-half of the year as the outlook for future growth remains clouded with uncertainties. As a result, the central bank may surprise the markets and keep the benchmark interest rate on hold next month in an effort to mitigate the downside risks for the region.

How To Trade This Event Risk

Expectations for an expansion in Canada’s growth rate favors a bullish outlook for the loonie, and price action following the release could set the stage for a bullish Canadian dollar trade as the economic outlook improves. Therefore, if GDP increases at an annualized pace of 2.5% or higher, we will need to see a red, five-minute candle following the data to establish a sell entry on two lots of USD/CAD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing high or a reasonable distance after taking market volatility into account, and this risk will generate our first target. The second objective will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its target in order to preserve our profits.

In contrast, the slower pace of expansion in business activity paired with the downturn in private spending could lead to a dismal growth report, and a weaker-than-expected GDP reading could weigh on the exchange rate as investors scale back expectations for a rate hike next month. As a result, if economic activity expands at an annual pace of 1.3% or less, we will favor a bearish outlook for the Canadian currency, and will utilize the same strategy for a long dollar-loonie trade as the short position laid out above, just in reverse.

Potential Price Targets For The Release

Impact Canada GDP had on CAD during the previous quarter

1Q 2010 Canada GDP

Economic activity in Canada expanded at an annualized pace of 6.1% in the first quarter, which exceeded expectations for a 5.9% rise in the growth rate and marked the fastest pace of growth since 1999. The breakdown of the report showed consumer spending increased 1.1% paired with a 5.4% rise in home investments, while fixed capital investments advanced 2.0% during the first three-months of 2010. As the economic recovery gathers pace, market participants expect the Bank of Canada to normalize monetary policy later this year as Governor Mark Carney raises the outlook for growth and inflation, and speculation for rate hike could drive the Canadian currency higher against its U.S. counterpart as the Fed maintains its pledge to hold borrowing costs close to zero for an “extended” period of time. However, the ongoing weakness in the U.S., Canada’s largest trading partner, could lead Mr. Carney to maintain a cautious outlook throughout the year as the world’s largest economy consumes nearly 80% of its major exports.

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.

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