Revisiting AUDCAD for Another Hedging Setup
Posted on April 30, 2008 in (Category: )
Revisiting AUDCAD for Another Hedging Setup
We had previously noted that though AUDCAD offered a rare interest rate arbitrage opportunity with the Bank of Canada following the Fed in cutting borrowing costs and the RBA firmly on hold at 7.25%, conditions had soured as traders begin to entertain the hope that the US has seen the worst of the current housing crisis. Positive sentiment echoed across markets as Canada’s benchmark stock index rose to a monthly high and the yield on the two-year Canadian government bond reached a two-month high as the market re-evaluated the extent of BOC monetary easing.
On April 3rd, the pair broke through this trend line and settled above support at 0.9186, the 38.2% Fibonacci retracement of the 01/30–03/25 ascent. At that time, we suggested a hedge trade as the pair pulled back up towards the trend line prior to further decline. We cautioned that a trend change in AUDCAD is closely contingent on current US sentiment, and should sentiment towards the US sour again the pair may hold more upside potential. To that effect, we noted it would be important to follow price action around upcoming data releases (notably, ISM and NFP that week) to gauge the market’s mood.Our cautionary stance was warranted. As we had expected, AUDCAD was setting up to retrace from Fib support back towards the trend line resistance level. Surprisingly, price action continued higher to close above the previously broken trend line. The NFP report had printed decidedly grim for the US economy, showing job losses of -30k more than expected as well as revising lower the previous month's result. With such a shift in fundamental outlook, we closed the trade at the hedge position’s profit target having neither lost nor gained.
The decision to close out the AUDCAD hedge position proved wise - the pair rallied substantially to close above the triple top resistance that we had been looking at. The hedging approach proved very useful in this case, allowing us to speculate on a potential trend change without significant exposure to market risk. Though the trend change did not materialize, our equity remained largely unscathed and we were left free to look to other trading opportunities.
Revisiting the pair today, AUDCAD has rallied to a high of 0.9500. The pair has not traded here since a year ago, having put in a major top at the same level last April prior to declining by 800 pips in the next 2 months. We expect price action to retrace from this resistance back to the broken triple top level at 0.9370, prior to a resumption of the upward trend in favor of the yield gap.