Lines in the Sand - The Technical Analyst...Lines in the Sand USD/CAD: The Party is O-v-e-r! FIC TECHNICAL STRATEGY I RESEARCH George Davis, CMT Chief Technical Analyst RBC Dominion

Lines in the Sand

USD/CAD: The Party is O-v-e-r!

FIC TECHNICAL STRATEGY I RESEARCH

George Davis, CMT

Chief Technical Analyst

RBC Dominion Securities Inc.

(416) 842-6633

[email protected]

January 30, 2013

This report was priced on January 29-30, 2014 (unless otherwise noted).

For Required Conflicts Disclosures, please see page 19.

January 30, 2014 2

Table of Contents

Abstract 3 Key themes and conclusions 4 Short-term tide turns for USD/CAD on the daily chart in May 2013 5 Various pattern breakouts signal an intermediate trend reversal in H1 2013 6 USD/CAD now poised for major long-term trend reversal on the monthly chart 7 EUR/CAD completes inverted head and shoulders pattern 8 GBP/CAD resolves a rectangle pattern to the topside 9 USD/CAD correlations post major shifts; watch rate spreads 11 10-year US-CAN rate spread underpins USD/CAD rally 12 USD/CAD tracking US-CAN 1y/1y forward swap rate spread 13 Economic surprises working against CAD 14 Oil price spreads having minimal impact on USD/CAD 15 Huge breakdown between USD/CAD and TSX Energy Index 16 Inverse relationship between USD/CAD and the ADXY 17 USD/CAD decouples from the VIX 18

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Abstract

All asset markets move in cycles, with bullish and bearish sentiment defining the psychological components of fear and greed. When the cycles reach an inflection point, major support or resistance levels are often broken, with the resulting trend reversal(s) signaling that a significant change in sentiment has taken place. These outcomes can also sometimes produce major shifts in key intermarket relationships, as the change in sentiment reverberates across asset classes. With the CAD being the worst performing G10 currency so far this year, we take this opportunity to assess the technical damage across short (daily chart), intermediate (weekly chart) and long-term (monthly chart) time horizons in order to determine whether or not the price cycles and intermarket relationships are shifting in a material way.

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Conclusions

Our analysis suggests that USD/CAD is on the verge of, or has already triggered, significant trend reversals across the short, intermediate and long-term time horizons.

Notably, after a deterioration in the short and intermediate-term technical backdrop over the past year, the long-term downtrend is on the verge of a major reversal similar in scope to that seen back in 2002.

In addition, the CAD is depreciating across the board, not just against the USD. EUR/CAD and GBP/CAD are cases in point.

A significant shift in cross asset relationships has also taken place – with equity markets losing their importance and interest rate spread relationships increasing in importance as the Bank of Canada voices concern over the lack of inflation.

Surprisingly, commodity and energy-related linkages continue to assert the least influence on CAD in the current environment.

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January 30, 2014 55

Tide turned for USD/CAD on daily chart back in May 2013

We shifted to a bullish short-term outlook for USD/CAD back in May 2013, when prices pierced a triangle top at 1.0220.

Since that time, the evidence has pointed to the completion of a bottoming pattern, or long base.

The recent daily close above the 2010 high at 1.0853 corroborated this thesis and upheld the transition from a bearish to a bullish backdrop.

With the daily studies attempting to trace out a bearish divergence from overbought levels, a corrective pullback is expected to materialize over the next month or so and would be confirmed by a close below initial support at 1.1098.

However, the overall uptrend in place suggests that valuation-driven pullbacks to secondary support at 1.0853 and 1.0708 will attract buying interest for a push to new cyclical highs.

The next resistance target is located at 1.1236 in this regard (50% Fibonacci retracement of the 2009-2011 decline), followed by 1.1439 and 1.1668 (61.8% retracement).

We stress that a daily close below the trendline drawn from the September 2012 lows at 1.0411 is required to nullify the bullish backdrop.

Key Support & Resistance Levels:

Support: 1.1098 1.0853 1.0708

Resistance: 1.1236 1.1439 1.1668

Source: Bloomberg, RBC Capital Markets

RSI and stochastic studies tracing out overbought divergences

Pivot for bullish backdrop @ 1.0411

Close below 1.1098 required to trigger a retracement, with 1.1236 and 1.1439 serving as the next resistance levels

Bullish breakouts amplified by prices being above the 200-dma and Ichimoku Cloud

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Weekly chart highlights key retracement levels in USD/CAD

The weekly chart illustrates many of the technical concepts discussed on the previous slide.

Notably, you can clearly see the bullish triangle breakout from last May, the subsequent break above the 2010 high at 1.0853, and if you observe the price action since 2009-2010, you can see the rounding bottom pattern as well.

In fact, the triangle can also be viewed as a complex inverted head and shoulders pattern – with the break above the neckline at 1.0244 confirming a significant shift in sentiment via the completion of a reversal pattern.

Taken this way, the pattern has a measured move objective of 1.1461.

We note that 38.2% Fibonacci retracement of the 2009-2011 decline at 1.0804 has already been exceeded, with 50% and 61.8% retracement levels at 1.1236 and 1.1668 serving as intermediate resistance levels, followed by 1.1762 and 76.4% retracement at 1.2202.

Although the weekly studies are near overbought levels, pullbacks to support at 1.0413 and the old triangle top at 1.0132 are expected to attract intermediate buying interest.

A weekly close below the triangle base at 0.9916 is required to nullify the bullish intermediate view.


Support: 1.0868 1.0413 1.0132

Resistance: 1.1236 1.1668 1.2202


Weekly studies approach overbought levels


Inverted head & shoulders pattern has a measured move objective of 1.1461

Retracement levels to watch

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The clincher: USD/CAD poised for bullish monthly reversal

The bullish backdrop discussed on the daily and weekly charts is set to be corroborated by the long-term monthly chart as well.

Specifically, a monthly close above a 12-year resistance trendline at 1.0560 on January 31 would confirm a bullish long-term trend reversal in USD/CAD.

This would flag a major shift in sentiment that would be similar to the bearish secular trend change that took place on the break below a 12-year support trendline at 1.5412 in 2003 (note that both bull and bear markets have been 12 years in duration).

Furthermore, the shift to the bullish camp would be amplified should prices also be able to close above the Ichimoku Cloud top at 1.1083.

Initial long-term resistance targets are located at 1.1725 and 1.1999 (38.2% retracement of the 2002-2011 decline), followed by 1.2193 and 1.2800 (50% retracement).

If the bullish breakout is valid, then pullbacks to support at 1.0560 and 1.0178 should attract long-term buying interest.

A close below the trendline drawn off of the 2007 and 2011 lows at 0.9653 will be required in order to nullify the bullish backdrop.


Support: 1.0560 1.0178 0.9653

Resistance: 1.1725 1.1999 1.2800


Monthly valuations still neutral


Note the powerful break above the long-term resistance trendline and Ichimoku Cloud. Next resistance

levels located @ 1.1725 and 1.1999

Long-term retracement levels

to watch

12 year uptrend 12 year downtrend

Double bottom forms after M&A induced selling

climax in 2007

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EUR/CAD completes inverted head and shoulders pattern

CAD weakness has not just taken place against the USD – the Loonie has also underperformed significantly on most of the major crosses.

EUR/CAD is a case in point, with bullish fanline breakouts above resistance at 1.2846 and 1.3399 creating an ascending channel pattern.

We note that the resulting weekly close above a quadruple top at 1.4352 in late November resolved an inverted head and shoulders pattern to the topside.

This was confirmation that a major low was in place and that a significant shift in sentiment was underway.

With 38.2% and 50% Fibonacci retracement of the 2009-2012 decline at 1.4183 and 1.4818 already exceeded, 61.8% retracement at 1.5452 serves as the next resistance level to watch.

A weekly close above here would then expose secondary resistance at 1.6033 ahead of 76.4% retracement at 1.6237.

The inverted head and shoulders pattern has a measured move objective of 1.6575.

If the recent breakout is valid, then valuation-driven pullbacks to support at 1.4818 and 1.4352 should attract buying interest.

Place a stop below the ascending channel base at 1.3962 for this view.


Support: 1.4818 1.4352 1.3962

Resistance: 1.5452 1.6033 1.6237


Studies reach overbought levels

Pivot for uptrend @ 1.3962

Inverted head and shoulders pattern has a measured move objective of 1.6575

Next retracement levels to watch

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GBP/CAD resolves rectangle pattern to the topside

The long-term downtrend in GBP/CAD stalled between 2010-2013 via the formation of a rectangle pattern.

A hint as to the next directional move took place in late 2013 when the cross pierced the double top at 1.6454 that formed the upper boundary of the rectangle.

This indicated that a major low was in place, with prices subsequently reaching and exceeding the measured move objective for the pattern at 1.7618.

Although the overbought extremes on weekly studies suggest that a pullback is in order, the recent shift in sentiment indicates that valuation-driven pullbacks to support at 1.7934 and 1.7458 should attract renewed buying interest.

Initial resistance targets are located at 1.8652 and 1.9017, followed by the 2009 high at 1.9304 that is just above 50% Fibonacci retracement of the 2007-2010 decline at 1.9201.

61.8% retracement is located above here at 2.0231.

A weekly close below 1.6454 will be required to fully nullify the bullish backdrop, but we would implement 1.6963 as a stop to improve risk/reward.


Support: 1.7934 1.7458 1.6963

Resistance: 1.8652 1.9017 1.9304


Studies reach overbought extremes

Triple bottom forms a basing pattern

Bullish rectangle breakout highlights 2009 high @ 1.9304

Next retracement levels to watch

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January 30, 2014 10

Intermarket and Cross Asset Analysis

The first three charts analyzed indicated that USD/CAD has already posted major short and

intermediate-term trend reversals - and is poised to register a major long-term trend reversal

this month. Furthermore the last two charts indicated that CAD weakness has not been just

against the USD. Rather, the CAD has traced out important peaks on many of the major

crosses, including EUR/CAD and GBP/CAD.

Given the significant shift in sentiment that has taken place, we now review some key

intermarket considerations in order to determine which cross asset relationships continue to

hold and, more importantly, which ones have broken down in conjunction with the various

trend reversals.

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-1

-0.9

-0.8

-0.7

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0

Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13

World equities Crude oil Base metals 2yr CA-US swap spreads

USD/CAD correlations post major shifts; watch rate spreads

The negative correlation between USD/CAD and equities had been one our preferred intermarket metrics to assess the risk backdrop.

This relationship began to dominate in 2008 as the onset of the US credit crisis gave way to the “risk on/risk off” dynamic that drove asset allocation.

However, this relationship began to weaken in late 2012, with the correlation moving from well below -0.80 to just -0.40 currently.

Indicates that markets have moved away from the “risk on/risk off” dynamic to a more “traditional” response to economic data as the Fed taper begins.

Note that the negative correlation between USD/CAD and base metals, 2-year CA-US swap spreads (interest rates) and crude oil has also eroded in significance since 2012.

Interest rate spreads currently have the most significant negative correlation, suggesting that they will remain a focal point going forward.

Note that crude oil continues to have the least significant negative correlation with USD/CAD.


Current correlations:

Stocks: -0.40 Base metals: -0.37 2-yr CA-US swap spread: -0.45 Crude oil: -0.27

Correlations are based on 1-year weekly rolling changes

Reduced importance of equities indicates that a shift away from the “risk on/risk off” dynamic has taken place; interest rate spreads currently the most significant factor in response

to BoC concerns over lack of inflationary pressure

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January 30, 2014 1212

10-year US-CAN rate spread underpins USD/CAD rally

With interest rate spreads taking

on increased importance, we note

that a sharp widening in the 10-

year US-CAN yield spread has

taken place since last October,

with the spread moving from +4

bps to +33 bps in favour of the US.

Also note the sharp rally in

USD/CAD that has simultaneously

taken place since then, with the

pair rallying from 1.0280 to 1.1199.

Hence, this relationship

corroborates the impact that rate

spreads are having on USD/CAD

and merits close attention going

forward.


USD/CAD rallies in lock-step with widening in 10-year US-

CAN yield spread

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January 30, 2014 1313

USD/CAD tracking US-CAN 1y/1y forward rate spread

Another take on the interest rate

angle is to explore cross market

relationships between forward

swap rate spreads.

In this case, we plot USD/CAD

against the US-CAN 1-year/1-year

forward rate spread.

Note that the spread has widened

sharply since mid-November,

moving from -101 bps to -64 bps.

Also note that during this time,

USD/CAD surged from 1.0437 to

1.1199.

Again, this relationship

corroborates the impact that rate

spreads are having on USD/CAD

and merits attention going forward.


USD/CAD fairly valued based on sharp widening in US-CAN 1y/1y

forward swap rate spread

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January 30, 2014 1414

Economic surprises working against CAD

Economic surprise indices are a

simple way to measure whether

economic data is beating or falling

short of consensus expectations.

Hence, a comparison between the

US and Canada using this metric

may provide some interesting

insight as to whether the

macroeconomic data is

corroborating the CAD weakness.

In this instance we calculate

another spread: the difference

between the Citigroup Economic

Surprise Index for the US and a

similar measure for Canada.

This metric indicates that the US

has outpaced Canada in terms of

positive economic surprises since

last November, with the spread

moving from -39 to +75.

USD/CAD has rallied from 1.0437

to 1.1199 during this period.

Hence, the economic data has also

corroborated CAD

underperformance.

From a fusion analysis perspective,

this relationship also deserves

some attention going forward.


Positive economic data surprises in the US have outpaced those in Canada,

contributing to the rally in USD/CAD

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January 30, 2014 1515

Oil price spreads having minimal impact on CAD

When we took a look at various correlation metrics for USD/CAD on slide 11, we pointed out that crude oil has largely had the least significant negative correlation with USD/CAD over the last two years.

This is somewhat surprising as many like to think of CAD as a petrocurrency.

We recall that from a commodity perspective, the widening in the WTI-WCS (Western Canadian Select) oil spread has triggered CAD weakness at various times – notably from September 2012 to December 2012 (the spread moved from $12 to $46.56) and June 2013 to November 2013 (the spread moved from $10.47 to $42.94).

This was due to concerns over the trade impact from Eastern Canada paying more to import WTI crude relative to what Western Canada was receiving to export WCS.

However, note that the spread is not currently contributing to CAD weakness, as it has actually improved from $42.94 in November to $18.10 currently).

As such, it appears that other factors are at work and weighing on the CAD.


Widening in WTI-WCS spread hits CAD at various times in 2012 and 2013

Spread not currently contributing to CAD

weakness

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Huge breakdown between CAD and TSX Energy Index

CAD has historically had a positive

correlation with the TSX Energy

Index, with the correlation above

0.70 at various times in 2010, 2011

and 2012.

Note that the correlation started to

become more erratic in 2013,

oscillating back and forth between

positive and negative values.

However, this year the correlation

has plunged to -0.39 – the lowest

level in over 6 years.

Hence, energy prices do not seem

to be having a directional impact

on CAD in the current environment.


CAD decouples from TSX Energy index

Correlation hits new lows

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Inverse relationship between USD/CAD and the ADXY

USD/CAD has generally displayed

an inverse relationship with the

ADXY (the JP Morgan Asia Dollar

Index).

With China having the largest

weight in the ADXY, this

relationship is largely a take on the

growth outlook (i.e. a rally in the

ADXY corresponds to a positive

outlook for Asian growth and is

positive for CAD and vice versa).

Note that the ADXY peaked in

2011 as concerns over Chinese

economic growth began to

escalate.

USD/CAD bottomed at the same

time and has been trending upward

since then as the ADXY trends

lower.

However, the recent spike higher in

USD/CAD has not been matched

by an equally sharp move lower in

the ADXY, again suggesting that

other factors may be behind the

move.

Nonetheless, from a trend

perspective, an offered tone in the

ADXY is still considered a bullish

factor or USD/CAD (and vice

versa).


Inverse relationship between USD/CAD and ADXY, but recent spike higher in USD/CAD has not been corroborated by a sharp

move lower in the ADXY

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January 30, 2014 1818

USD/CAD decouples from the VIX

There has been a tight relationship

between USD/CAD and the VIX

dating back to 2008.

Generally, the CAD has weakened

during times of increased volatility

and rallied during periods of

decreased volatility.

However, this relationship began to

break down last year as USD/CAD

began to post bullish short and

intermediate-term trend reversals

(as discussed on slides 5 and 6).

This remains the case, as

USD/CAD trends higher and the

VIX moves sideways.

Suggests that volatility related

“shocks” have not been a major

factor driving the CAD lower.


After posting a number of bullish trend reversals, USD/CAD is

decoupling from the VIX

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Fixed Income & Currency Strategy Research Team

Europe

RBC Europe Limited: James Ashley Chief European Economist +44‐20‐7029‐0133 [email protected]

Adam Cole Head of G10 FX Strategy +44‐20‐7029‐7078 [email protected]

Timo del Carpio European Economist +44‐20‐7029‐7085 [email protected]

Sam Hill, CFA Senior UK Economist +44‐20‐7029‐0092 [email protected]

Elsa Lignos Senior Currency Strategist +44‐20‐7029‐7077 [email protected]

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Asia‐Pacific

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Michael Turner Fixed Income & Currency Strategist +612‐9033‐3088 [email protected]

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North America

RBC Dominion Securities Inc.: Mark Chandler Head of Canadian FIC Strategy (416) 842‐6388 [email protected]

Ian Pollick Senior Fixed Income Strategist (416) 842‐6362 [email protected]

George Davis, CMT Chief Technical Analyst (416) 842‐6633 [email protected]

Paul Borean Fixed Income Strategist (416) 842‐2809 [email protected]

RBC Capital Markets, LLC: Michael Cloherty Head of US Rates Strategy (212) 437‐2480 [email protected]

Tom Porcelli Chief US Economist (212) 618‐7788 [email protected]

Jacob Oubina Senior US Economist (212) 618‐7795 [email protected]

Dan Grubert Rates Strategist (212) 618‐7764 [email protected]

Chris Mauro Head of US Municipals Strategy (212) 618‐7729 [email protected]

Andre Gutierrez Associate (212) 519‐8416 [email protected]

Documents

Lines in the Sand - The Technical Analyst...Lines in the Sand USD/CAD: The Party is O-v-e-r! FIC TECHNICAL STRATEGY I RESEARCH George Davis, CMT Chief Technical Analyst RBC Dominion