Canada’s central bank is “smoking something”!

Well, “intervention talk” is in the air again! This time it’s the Bank of Canada!



Why are they so concerned with their currency? Well the USD/CAD exchange rate has dropped from 1.30 to 1.07 (2,700 pips) in mere months (5 months to be exact).



This can wreak havoc upon a company that is trying to figure out how to hedge their currency exposure so that it doesn’t eat into the profits of their business…and the central bank realizes this too.



That’s why Central Bank Governor Carney, together with Finance Minister Flaherty are coming together to attempt to “jaw bone” the currency lower (in other words bring the USD/CAD exchange rate higher).



Canada’s Fed Governor has stated that the gain in the currency is a major risk to economic growth…adding that “he has the flexibility to deal with it”. The Finance Minister backed him up by saying “steps could be taken to dampen the (Canadian) dollar”.



Governor Carney is attempting to lessen the appeal of the loonie by stating that interest rates are likely to remain unchanged through at least the 2nd quarter of 2010.



You see, when you are a Canadian company and you’re trying to hedge against currency fluctuations of 5-10% in a short amount of time, it’s tough. (They really need my services. Hehe!)



Canada’s factory orders have been hit (down 29% since last July) as a result of the strengthening currency. That couldn’t come at a worse time because at the same time you’ve had General Motors and Chrysler shut down Canadian plants, dealers and parts suppliers. Manufacturers have had to fire 221,500 workers as a result.



Couldn’t they intervene? History says they won’t…and if they did, it will backfire!



So the central bank wants a lower Canadian dollar to make it easier on these crucial companies. Will they get it? NO! Oh sure, they may be able to influence the USD/CAD up 300-500 pips…but what is that when the pair has moved 2,700 pips downward and will continue that downtrend?



You see, traders know that the global economy is “on the mend” and as it is recovering, it will consume more oil and other commodities that Canada exports. They also know that the U.S. dollar has been in a broad downtrend since March (according to the U.S. Dollar Index). This broad U.S. dollar sell off isn’t going to change just because the Canadian central bank wants it to.



Oh yeah, but they could go in and “sell Canadian dollars” right? Sure they could…but, it would not be effective and the foreign exchange market would simply laugh at them with the trend and fundamentals going in the favor of the traders and against that of the bank.



Also, traders know that there’s a good chance that the bank is bluffing too. Why? The central bank has abandoned intervention policies ever since 1998. They didn’t intervene when the currency reached a record high in 2007 and or when it’s had its biggest gain since the Korean War during May.



Therefore, there are a ton of years there that the bank did nothing when the currency moved to extremes. So they have no reason to believe that it will be any different this time.



Most of the time, they just “jaw bone” the currency by talking about what they “could” do. However, when push comes to shove, they usually don’t anymore.



They stopped intervening in 1998 because it simply ended up causing even more volatility and ended up making it even more difficult for their exporters to hedge their risks.



If they “talk the pair up”, short the rallies!



Therefore, here’s how I see this playing out on the chart below. Sure, they may “talk the currency up” a few hundred pips or more in the near term. It could happen. However, smart traders are “selling rallies” in the USD/CAD pair because the trend is down and the fundamentals overall, are on the mend. Therefore any bounce upward, is likely to result in another big push downward.



So “shorting rallies” is the flavor of the day, these days.