Trade ideas can come from surprising sources. The team here at CMC Markets were looking at USD/JPY yesterday, and although there are a number of interesting factors in play (competitive devaluation, trade and debt issues, as well as chart set-ups) the overall lack of volatility makes it hard to recommend. This led to a search for more volatile currency pairs – and a surprising result.
The top of the (1 month) volatility list is the South African rand, followed by a number of Eastern European currencies. Restricting the list to G20 countries, the CAD/NOK cross attracts attention. This appears unusual because the Canadian Dollar and Norwegian Kroner are both considered “commodity” currencies, and formerly moved in broadly the same direction in the “risk on, risk off” trading of 2010 and 2011.
This heightened volatility suggests things have changed. First, here’s the chart:
Source: CMC Tracker
Note the clear downtrend since July, and the key support levels at current prices. Naturally, identifying fundamental drivers strengthens the case. And it turns out there are a couple of reasons to support a weaker CAD / stronger NOK.
Firstly, the interest rate differential favours NOK. Short rates in CAD are 1%, versus 1.5% in NOK. One year rates show a greater disparity – 1.6% versus 2.3%.
However, in my view, the greater driver is a divergence in their trade balance. Due to oil exports, Norway persistently reports trade surpluses. Peaking at 50 billion NOK a month earlier this year, the most recent reading showed a surplus of 23 billion NOK. In contrast, Canada’s trade balance is showing signs of long term deterioration.
Pre GFC, Canada trade balances were rudely positive. Since 2009, they have fluctuated between positive and negative. In August, they reported the lowest reading in more than 5 years – a deficit of 2.5 billion CAD. Although September showed a bounce, trade was still in deficit to the tune of a billion CAD.
This underlying supply/demand balance for “end users” of currencies can be a key long term driver of cross rates. Why is this important? Have a look at the long term chart:
Source: CMC Tracker
If the downtrend persists, the target levels are thousands of points away. Some traders will play this potential via a “swing” trade, establishing a short position and riding it down over days or weeks. Others may trade around a core position, trading in and out while maintaining an overall short. Regardless, an entry may look like:
Sell CAD/NOK on stop entry at 5.675, stop loss above 5.7000