Risk-Off Sentiment Prevails

With equities (and cryptocurrencies) tumbling, volatility is clearly there, even if this week will be a quieter one for economic data. But can volatility remain elevated, especially towards the end of the week with the Thanksgiving holiday being observed on Thursday in the US (and on Friday in Japan)?

Clearly some market participants would rather enjoy a long holiday break and await better opportunities next week. However, this time it may be different, and traders may actually hang around as volatility has not been at these elevated levels for prolonged periods in a while.

FX traders will be curious to find out whether the stock market sell-off will gather pace, as this could keep the safe-haven Japanese yen bid, potentially meaning bearish USD/JPY, especially in light of last week’s cautious assessment of the US economy by two Federal Reserve members.

For FX traders, it therefore makes more sense to watch/trade currencies which are more sensitive to changes in risk appetite this week – in other words, those that have the greatest correlation with the stock markets.

The likes Japanese yen, Swiss franc and of course commodity dollars fit the bill. In fact, the commodity dollars have all started this week on the backfoot, owing in part to the general 'risk-off' tone to global markets.

With the release of Canada’s CPI and retail sales on Friday being the exception in an otherwise quiet week for data, the USD/CAD, CAD/JPY and other CAD crosses should garner most of the attention in FX space. Thus, if Friday’s Canadian data were to disappoint and given the sizeable sell-off in oil prices recently, then we could see the Canadian dollar extend its losses as investors turn more pessimistic on the North American nation’s economic outlook.

If the Canadian dollar is going to move on the back of the upcoming data, particularly to the downside, then the CAD/JPY could potentially be an even more interesting pair to watch.

As my colleague Matt Weller highlighted, the trend for the USD/CAD is still bullish, meaning bearish for CAD. And with yen finding some safe-haven flows, the CAD/JPY could actually head lower even before Friday’s Canadian macro pointers are released – unless sentiment towards risk unexpectedly improves now.

Technically, the short-term outlook on the CAD/JPY is indeed bearish given the fact it has been printing lower lows and lower highs since peaking at 89.20 in early October. That being said, price is now testing a key short-term trend line around 85.30 and there is the possibility it could bounce back from here.

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Given the above considerations, however, we think that it is more likely the CAD/JPY breaks down than stages a rally from here.

So, if we are corrected, the losses could potentially accelerate for this pair, with the next short-term objective being the liquidity underneath the October low at 84.86. But potentially the breakdown of the trend could pave the way for even greater losses, perhaps similar to the previous breakdown of a trend line back in February.

Conversely, if we are wrong and the trend holds, we would drop our bearish view only if price goes on to make a higher high. The most recent short-term high was made last week at 86.35, so this is the line in the sand now. A break above here would end the short-term bearish view, although for the longer-term picture to change we will need price to take out more significant levels at higher levels.