January 31, 2023

Long CAD/JPY as Interest Rate Differential Begins to Bite: Top Trade Q1 2022

The coming year will see a raft of global central banks reversing their loose, pandemic monetary settings of the last two-years decisions and begin to normalize monetary policy by withdrawing emergency stimulus measures and hiking interest rates. Major central banks, including the Federal Reserve, the Bank of England, the Reserve Bank of Australia, and the Bank of Canada, have already given markets a strong heads-up about what is to come over the next few months.

One central bank however that will not be raising interest rates is the Bank of Japan, even though their short-term policy rate sits 10 basis points in negative territory. In contrast, the Bank of Canada (BoC) is expected to hike its cash rate by 25 basis points in January to 0.50% to stem above-target inflation. And this will be just the start for the BoC with markets now pricing in a total of 130bps of rate hikes during 2022, widening the interest rate differential with Japan markedly. This yield differential will show up in, and weaken CAD/JPY in a classic ‘long high yield currency/short low yield currency’ trade.

CAD/JPY Weekly Price Chart – December 10, 2021

While this quarterly idea may be better suited to a longer time frame, the recent weakness in CAD/JPY offers an opportunity to enter the trade at a better level than previous weeks have offered. The Commodity Chanel Index (CCI) has washed out the extremely overbought positioning seen in mid-October on the weekly chart and is just starting to point higher again. The 50-day/200-day sma crossover gives the longer-term chart a bullish bias, while the latest weekly candle has broken a series of shorter-term lower highs. A confirmed break back above 91.59 and 93.02 would open the way back to highs last seen in August 2015.

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