Canadian Dollar Hedging Update

Transcription

1 Global FX Strategy George Davis, CMT Chief Technical Analyst Patric Booth Managing Director, FX Options Canadian Dollar Hedging Update Decision Time USD/CAD Testing Key Resistance Level at FX Hedging Implications and Proposed Strategies: Sellers of USD/CAD should focus on resistance at , and as part of our active layered hedging strategy. A 3-month cable car option could also be incorporated for additional flexibility. Buyers of USD/CAD should focus on support at , and as part of a disciplined layered hedging strategy. In addition, a 3-month forward extra strategy could be considered. Refer to the Summary and Conclusions section on page 5 for specific details. Key Themes The risk aversion theme is a key driver of investor behaviour in the current market environment. Price action in equity markets will be paramount in determining the directional bias of FX markets in general and USD/CAD in particular. Although a short-term corrective phase is likely to develop in equity markets, we still see the risk of another intermediate-term selloff, providing USD/CAD with the scope for another test of a key resistance level at Thematic Review Volatility Vortex In our last hedging strategy publication, we reiterated our bullish technical thesis for USD/CAD (see Volatility Vortex, published on December 10, 2008). Our main argument revolved around the fact that FX volatility was expected to remain at elevated levels, with price moves in equity and commodity markets serving as the main catalysts for directional moves in USD/CAD. With another leg lower in both equities and commodities expected, our view was that the negative correlation between USD/CAD and these two asset classes would favour another probe higher in USD/CAD. Based on bullish medium and long-term trend reversals registered in August 2008 and November 2007 respectively, our analysis highlighted resistance levels at , and as topside price targets for our core view. With rising levels of risk aversion dominating the investor decision-making process, a brief year-end rally came to a screeching halt in the first week of January. Deleveraging flows weighed on equity and commodity markets in this regard, with bearish market sentiment causing both asset classes to move to new cyclical lows through the end of February and into early March. This resulted in USD/CAD producing a bullish trend reversal above in early January and trading up to a high of on March 9. The rally to the region upheld our bullish thesis for USD/CAD and produced some favourable results for the hedging strategies that we proposed back in December. We examine our results on the next page. For pertinent disclosures, please see last page. See RBC s research at

2 Global FX Strategy: Decision Time Sellers of USD/CAD Spot Strategy Proves to be a Better Alternative Prices reached two of the three proposed entry levels for the spot portion of our hedging strategy. With USD/CAD reaching a high of on March 9, our orders to sell USD/CAD at and would have been executed. Our third resistance level at would not have been reached. This would have resulted in an average rate of for the executed orders. While this would have represented an improvement of 90 points over the settlement rate of on March 10, the correct method to assess the performance of these strategies is to compare them to the forward outright rate for the period in question. As the 3-month forward outright rate for December 10 to March 10 was (using a spot reference rate of and a forward rate of -10 points) our proposed spot strategy would have been able to outperform the forward outright rate by 250 points. The option component of our strategy would have also been executed based on USD/CAD trading above Recall that this structure was termed a 3-month forward extra strategy where a USD put would have been purchased with a knock out at and a USD put would have been purchased with a knock in at In addition, a USD call would have been sold with a knock in at With the barrier level at trading in early March, the client would have been locked in to selling USD/CAD at the outright rate of Hence this strategy would have produced neither a benefit nor an opportunity loss, as the client s sale rate of would have been the same as the forward outright rate. Given these results, the spot portion of our strategy would have been the more optimal alternative as it was able to outperform both the forward outright rate and the option strategy. Buyers of USD/CAD Spot Strategy Superior to Forward Outright and Option Strategies All three of the recommended spot levels were attained for those who had to purchase USD/CAD between December 10 and March 10. We note that USD/CAD traded down to a low of on January 6 as volatile trading conditions remained the norm for markets. This ensured that all of our proposed entry levels for long positions - at , and would have been realized. Based on an average rate of , the spot portion of our strategy would have outperformed the forward outright rate of by 357 points. Our option strategy would have been executed as the level traded over the life of the option. The strategy consisted of a 3-month knock-in tunnel that involved purchasing a USD call and selling a USD put with a reverse knock in at As the barrier at would have traded during the life of the option, the client would have had to purchase USD/CAD at the prevailing option expiry rate of on March 10. Thus, this strategy would have underperformed the forward outright rate of by 160 points. Therefore, the spot portion of our strategy would have repeated as the more preferential alternative as it was able to outperform the forward outright rate and the option strategy as well. Looking Ahead: Technical Market Outlook and Proposed Hedging Strategies Pages 3 and 4 examine USD/CAD from a medium and long-term technical perspective in order to derive key price levels for consideration in our new 3-month hedging strategies. 2

3 Global FX Strategy: Decision Time March 16, 2009 Medium-Term Technical View: Consolidation Viewed as a Continuation Pattern Daily USD/CAD Candle Chart: Key Triangle Pattern Resistance at Source: Tradermade International Ltd. Key Resistance Located at Must Be Exceeded for Bullish Breakout USD/CAD must register a daily close above the quadruple top at in order to affirm our bullish technical thesis. USD/CAD tested key resistance at on March 9 and actually managed to exceed this level on an intraday basis. However, the euphoric mood of the USD/CAD bulls was dashed by the end of the day as overbought readings on the daily studies prevented prices from registering a daily close above this key level. Hence, we expect to see a short-term, valuation-driven pullback in USD/CAD after the stern rejection of the area formed a quadruple top. Despite this fact though, we continue to view the ascending triangle pattern that has formed since last October as a continuation pattern. Given that an uptrend was in place before the triangle pattern formed, our core technical thesis is that USD/CAD will eventually resolve the pattern to the topside. As such, we view pullbacks to support at , and as a buying opportunity for yet another test of the key resistance level at A daily close above this level would confirm our bullish thesis, with the pattern breakout favouring greater gains toward , followed by Given the maintenance of our bullish thesis, rallies to resistance at , and should present a medium-term hedging opportunity for clients that require selling USD/CAD. On the other hand, those who have requirements to purchase USD/CAD will have to focus on the support levels identified at , and

4 Global FX Strategy: Decision Time Long-Term Technical View: Valuations Becoming a Concern? Monthly USD/CAD Candle Chart:50% Fibonacci Retracement at as Pivot Point Source: Tradermade International Ltd. 50% Fibonacci Retracement at Exceeded on Monthly Closing Basis The long-term retracement phase in USD/CAD is beginning to lose upward momentum near the level as valuations reach overbought levels. USD/CAD remains in a retracement phase after producing a bullish long-term trend reversal above a 5-year resistance trendline at in August While prices have been able to register a monthly close above 50% Fibonacci retracement of the decline at , the rally has started to lose some traction near as the monthly studies move to overbought levels. We note that the longer-term studies can remain at such extremes for multi-month periods - but we stress that we will have to see a monthly close above in order to sustain the current advance. In terms of additional resistance levels, there is minor resistance at , followed by the 61.8% retracement level at , and the 2004 reaction high at We have no evidence of any bearish trend reversals yet, so we are operating under the premise that support at , and will attract buying interest based on the uptrend that is in place. A monthly close below would shift our long-term view from bullish to neutral with a close below required in order to end the retracement phase via a full-blown bearish trend reversal. With USD/CAD struggling to sustain moves above the area as the monthly studies reach overbought levels, we highlight resistance at , and as levels that can be considered for inclusion in a long-term hedging strategy by those who have a requirement to sell USD/CAD. Conversely, support levels at , and can be considered by those who are on the other side of the fence and have requirements to buy USD/CAD. 4

5 Global FX Strategy: Decision Time March 16, 2009 Summary and Conclusions: With risk aversion a key driver of investor behaviour, price moves in equity markets are likely to be the primary determinant of directional bias for USD/CAD. Commodity markets also remain an important factor, but our correlation analysis currently shows that this asset class ranks a distant second to equities in importance. Although the probability of a short-term correction higher in equities is increasing, we are expecting another intermediate leg lower to develop thereafter as a longer-term downtrend persists. USD/CAD remains within medium and long-term uptrends on the daily and monthly charts in this regard (and from an intermarket perspective). A key daily and monthly resistance level at must be exceeded on a closing basis in order to sustain our bullish technical thesis and continue the upmove. Our analysis highlights key medium and long-term resistance levels at , and Support is located at , and Proposed Hedging Strategies Based on the conclusions presented above, we propose the following 3-month hedging strategies for clients with FX exposure in USD/CAD: Sellers of USD/CAD: Rallies to resistance at , and will present an opportunity to sell USD/CAD over the next 3 months as the current uptrends mature. We always recommend a layered spot strategy that incorporates multiple resistance levels as it is difficult to pick the ultimate high for a price move. This strategy allows the hedger to average in to cover required exposures rather than hoping that prices reach one ultimate level against which the entire hedging requirement can be completed, only to miss the entire opportunity should the rally fall short. Alternatively, using a spot reference of , clients can consider the use of a 3- month cable car option. A USD put would be purchased and a USD call would be sold that knocks in at in order to generate a zero-cost structure. Therefore, the client would be protected at as a worst case scenario and can sell USD/CAD up to If trades at any time over the life of the option the client would have to sell USD/CAD at Buyers of USD/CAD: Selloffs to support at , and will represent an opportunity to buy USD/CAD over the next 3 months based on our active layered approach. Alternatively, using a spot reference of , clients can consider the use of a 3- month forward extra strategy. A USD call would be purchased with a knock out at and a USD put would be sold with a knock in at In addition, a USD call would be bought with a knock in at Hence the client would have the following scenarios: (1) the barrier does not trade and the client s worst case outcome would be buying USD/CAD at , while the best case outcome would be buying USD/CAD at , or (2) the barrier does trade and the client is locked in to buying USD/CAD at (very close to the forward outright rate of ). 5

6 Global FX Strategy: Decision Time As a comparative reference point for both option strategies, note that the 3-month forward outright rate to June 16, 2009 would be (using a spot reference of and a forward rate of -13 points). Please note that your RBC sales representative can put together a variety of other option structures that could be customized for specific client needs as well as time periods. 6

7 Global FX Strategy Russell Jones Global Head of Fixed Income and Currency Research Royal Bank of Canada Europe Limited Adam Cole Global Head, FX Strategy Royal Bank of Canada Europe Limited Sue Trinh Senior Currency Strategist Royal Bank of Canada, Sydney Branch Matthew Strauss CFA Senior Currency Strategist David Watt Senior Currency Strategist George Davis CMT Chief Technical Analyst RBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request. To access our current policy, clients should refer to or send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time. 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