Financial panic of 2008 caused many currencies to dramatically fall in value. In search of safe haven. investors and speculators alike flocked to the safety of US Dollar. At the same time last phase of carry trade unwind lifted Japanese Yen and put additional pressure on all other currencies. As a result, many of them fell dramatically, with some reporting 40%-50% declines. Huge moves by the standards of currency trading.
With normalization of global financial markets this year, money started to flow out of the Dollar. Once again market participants are willing to take a little extra risk in search of increased returns. This, over time, benefited many currencies which suffered the most during preceding market meltdown. Rising confidence slowly, but surely, pushed higher raw materials, like crude oil. This, in turn had positive effect on commodity currencies like Canadian, Australian and New Zealand Dollars.
In spite of increased confidence by investors world wide, economic conditions are far from levels that are considered normal. Unemployment remains on the rise, economic output is off the mark set in previous years and credit is tight. All that, even though central banks of most countries flooded financial markets with money through quantitative easing and slashing interest rates to record lows. In this environment, some governments came to see strength of own currency to be a competitive disadvantage and are taking steps to end it.
Swiss National Bank was the first to act. After repeated warnings,SNB intervened in the open market by selling Franc and denominated securities. This has happened at least three times in the course of last few months. We don't know if this action achieved results sought by central bank, but one thing is for sure- Swiss franc didn't make any new highs. Since no new statements about it were issued by Swiss financial authorities, we can assume they must see it as a success.
Recently Bank of Canada became very vocal about its currency. Canadian Dollar has appreciated greatly in last few months, gaining as much as 20% percent in relation to US Dollar. This worries officials, who claim that a stronger currency was a major risk to economic growth, or recovery. Officials stated repeatedly that if this was to happen, Bank of Canada will take steps to soften the effect.
Announcements like that are meant to influence market sentiment. Bank of Canada is hoping to convince market participants that it would be dangerous to keep buying CAD. This would have the desired outcome, without the active involvement of the Bank. Should this measure fall short, however, they will have to physically do something about it. Which might not be as easy as it seems.
Interest rates in Canada are already at historical low of 0.25%. Cutting rates makes currency less attractive for speculative purposes, but in this case there is no real room to maneuver. This means that only viable option is to be actively selling CAD in the open market. There is no doubt BoC would like to avoid this as much as possible, since interventions are expensive and long term consequences hard to predict.
When will the game of words turn into action? Currently, late August 2009, rate of USD-CAD is just under 1.1000 level. It is almost certain that the all time extreme of 0.9000 from two years ago, is safe. Logical line in the sand is 1.0000, the parity. It is very important psychological level. If, in spite of BoC verbal campaign, exchange rate falls under 1.0500, chances for intervention will increase exponentially.
Nobody knows for sure just how committed Canadian financial authorities are to their stated goal. However, given what happened in Switzerland, they might do it. Does it mean one should avoid trading Canadian Dollar from the long side? No, traders ought to stick to their strategies, but stop/loss orders are a must more than ever. Especially if USD-CAD is trading below 1.0500 and closer to parity.
No matter what happens, we will have an answer to couple on intriguing questions. First, how effective warning campaign by central bank is? Price moving above 1.1000 probably ends all talk about bank's involvement. If it fails, and the Loonie keeps getting stronger, we will find out just how serious Bank of Canada is about intervention. Will they deliver? Next few weeks will solve this puzzle.
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