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EUR/CAD Could Break To The Upside

Jun. 14, 2020 9:18 AM ETDRR, EUFX, EUO, FXC, FXE, ULE, URR
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Summary

  • EUR/CAD has been in a long-term bearish trend since the 1990s.
  • This has been in accord with a generally bearish trend for EUR, which the market has been generally sceptical of since its inception.
  • However, as oil recently collapsed, and as global rates have largely collapsed to the zero lower bound, the economics and appeal of carry trades have almost been eliminated.
  • EUR/CAD has therefore stabilized, and while it has recently found the long-term (bearish) trendline that has seemingly guided EUR/CAD price action since the mid-1990s, the response to the meeting with the trendline has this time been lackluster. Indecision now characterizes EUR/CAD.
  • While we may want to remain neutral on this pair at present, I believe that the EUR/CAD level of 1.60 will be well worthwhile to watch. If 1.60 is met in the short to medium term, this would be fairly unprecedented, since it would indicate a breaking above the long-term trendline and above the recent high, potentially signalling the start of a new direction.

The EUR/CAD currency pair, which expresses the value of the euro in terms of the Canadian dollar, is at least primarily a risk-off instrument. I say at least, because the relationship between the euro and global risk sentiment (in financial markets) is subject to change. That is, seemingly on a whim, dependent on the differences in performance across global equity indices.

If the S&P 500 (a proxy for U.S. equities) outperforms European indices, towards month- and quarter-end (and indeed, financial year-end), this can generate demand for euros as global portfolios rebalance in favor of underperforming markets (which generally rebalance in accordance with preselected portfolio weightings, and perhaps a tendency to trust the concept of mean reversion).

Further, the recent collapse in global interest rates has begun (at least, in my mind) to challenge the value of the U.S. dollar. While the U.S. dollar remains the world's reserve currency, the collapse in U.S. rates makes it far less appealing to hold U.S. dollars, at least from an interest rates perspective. The spread still favors USD over EUR (the Federal Reserve's current target rate of +0.00-0.25% is still higher than the European Central Bank's comparable deposit facility rate of negative -0.50%, but the spread is tight).

EUR and USD are therefore probably unlikely to deviate in value too significantly over the medium term. The Federal Reserve has suggested that U.S. rates are not likely to rise even through much of 2022. We can expect the Bank of Canada, representing the Canadian dollar, to probably follow suit over the long term. (The Bank of Canada's current rate is +0.25%.)

Nevertheless, as shown in the chart below, EUR/CAD is inversely correlated to the S&P 500 (which we can also use as a proxy for risk sentiment). In the chart below, the colored line represents

This article was written by

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Providing commentary and analysis, principally focused on global macro, foreign exchange, and equities as an asset class. Primary interests include equity investing from an international perspective, and FX fair values.

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