I group these three currency
pairs together because they share many of the same trading traits and even
travel as a pack sometimes - especially Aussie and Kiwi, given their regional
proximity and close economic ties. Whether they’re being grouped as the
commodity currencies, the commonwealth currencies, or just smaller regional
currencies versus the U.S. dollar, they can frequently serve as a leading
indicator of overall USD market direction.
Liquidity
and market interest are lower
One of the reasons these pairs
tend to exhibit leading-characteristics is due to the lower relative liquidity
of the pairs, which amplifies the speculative effect on them. If sentiment is
shifting in favor of the U.S. dollar, for example, the effect of speculative
interest - the fast money - is going to be most evident in lower-volume
currency pairs.
When a hedge fund or other large
speculator turns around a directional bet, on the U.S. dollar (for example,
from short to long), it’s going to start buying U.S. dollars across the board
(meaning against most all other currencies). A half-billion EUR/USD selling
order (650 million USD equivalent at 1.3000 EUR/USD) is relatively easily
absorbed in the high-volume, liquid EUR/USD market and may move it only a few
points (say, 5 to 10 pips, depending on the circumstances). However, a proportionately
smaller order to sell Aussie, sell Kiwi, or buy USD/CAD (large speculators will
typically allocate smaller position sizes to less-liquid currency pairs),
amounting to only 100 million or 200 million in notional terms, may generate a
10- to 40-pip movement in these currency pairs, depending on the time of day
and overall environment.
In general, you need to be aware
that overall liquidity and market interest in these pairs is significantly
lower than in the majors. On a daily basis, liquidity in these pairs is at its
peak when the local centers (Toronto, Sydney, and Wellington) are open. London
market makers provide a solid liquidity base to bridge the gap outside the
local markets, but you can largely forget about USD/CAD during the Asia/Pacific
session, and the Aussie and Kiwi markets are problematic after the London/European
session close until their financial centers reopen a few hours later. The net
result is a concentration of market interest in these currency pairs among the
major banks of the currency countries, which has implications of its own.
Price
action is highly event driven
As a result of the overall lower
level of liquidity in these currency pairs, in concert with relatively high
levels of speculative positioning (at times), you've got the ultimate mix for
explosive reactions after currency-specific news or data comes out. Change
Canadian tax policy so it inhibits foreign investment, and you're looking at a
sea change in sentiment against the CAD. lf expectations are running high for
an NZD interest-rate hike, and a key inflation report contradicts that outlook
(it's lower than expected), we‘ve got a relatively small market, probably over positioned
in one direction (long NZD/USD), that's all heading for the exit (selling) at
the same time.
The bottom line in these currency
pairs is that significant data or news surprises, especially when contrary to
expectations and likely market positioning, tends to have an outsized impact on
the market. Traders positioning in these currencies need to be especially aware
of this and to recognize the greater degree of volatility and risk they're
facing if events don’t transpire as expected. It’s one thing if Eurozone CPI
comes in higher than expected, but it’s another thing entirely if Australian
CPI surprises to the upside.
A data or event surprise
typically leads to a price gap when the news is first announced. If the news is
sufficiently at odds with market expectations and positioning, subsequent price
action tends to be mostly one-way traffic, as the market reacts to the surprise
news and exits earlier positions. If you’re caught on the wrong side after
unexpected news in these pairs, you’re likely better off getting off as soon as
possible than waiting for a correction to exit at a better level. The lower
liquidity and interest in these currency pairs mean you’re probably not alone
in being caught wrong-sided, which tends to see steady, one-way interest,
punctuated by accelerations when additional stop-loss order levels are hit.
All
politics and economic data is local
Most of our discussion of market drivers’
centers on economic data and monetary policy, but domestic political developments
in these smaller-currency countries can provoke significant movements in the
local currencies. National elections, political scandals, and abrupt policy
changes can all lead to upheavals in the value of the local currency. The
effect tends to be most pronounced on the downside of the currency’s value
(meaning, bad news tends to hurt a currency more than good news - if there ever
is any in politics - helps it). Of course, every situation is different, but
the spillover effect between politics and currencies is greatest in these
pairs, which means you need to be aware of domestic political events if you’re
trading in them.
In terms of economic data, these
currency pairs tend to participate in overall directional moves relative to the
U.S. dollar until a local news or data event triggers more concentrated interest
on the local currency. If the USD is under pressure across the board, for
instance, USD/CAD is likely to move lower in concert with other dollar pairs.
But if negative Canadian news or data emerges, USD/CAD is likely to pare its
losses and may even start to move higher if the news was bad enough. If the
Canadian news was CAD-positive (say, a higher CPI reading pointing to a
potential rate hike), USD/CAD is likely to accelerate to the downside, because
USD selling interest is now amplified by CAD buying interest.
Technical
levels can be blurry
The relatively lower level of
liquidity and market interest in these currency pairs makes for
sometimes-difficult technical trading conditions. Trend lines and retracement
levels in particular are subject to regular overshoots. Prices may move beyond
the technical level - sometimes only 5 to 10 pips, other times for extensive
distances or for prolonged periods - only to reverse course and re-establish
the technical level later.
The basic reason behind this
tendency to overshoot technical levels is that market interest is concentrated
in fewer market-makers for these pairs usually the local banks of the currency
country. The result is a concentration of market interest in fewer hands, which
can result in order levels being triggered when they may not be otherwise. For
example, if you're an interbank market-maker watching a stop-loss order for 5 million
AUD/USD, it’s not a big deal, because 5 million Aussie is transacted easily.
But if you have a stop loss for 50 million or 100 million AUD/USD, you’re going
to need to be fast (and, likely, pre-emptive) to fill the order at a reasonable
execution rate.
If the price break of a technical
level is quickly reversed, it’s a good sign that it was just a position-related
movement. If fresh news is out, however, you may be seeing the initial wave of
a larger directional move.
