At the turn of the year, AUD/CAD entered a bullish linear regression channel and has remained there to this date; however, there are indications this trend may consolidate at its current level or reverse.

This channel is best seen on daily charts, as illustrated below:

Although a case can be made for an earlier entry, the channel is definitely established by 28 December 2007 with the reaction low set at 0.8535, marked by the lower green line. Shortly thereafter, the price crossed above the 200-period moving average (the grey line) and the run began. For the most part, the price remained within the channel’s upper section, spiking near but never actually touching the lower boundary, in a tribute to the strength of bullish sentiment. This initial period came to an end on 9 June 2008 when the currency pair formed a reaction high at 0.9836, marked by the upper green line.

Of course, it was not recognised at the time that a significant resistance level had been reached; however, as five successive weeks passed (this is the sixth) and that resistance level has not been surpassed, an observant forex trader could be forgiven for wondering if it will be.

The main driver behind this run of almost precisely 1,300 pips was, of course, the interest rate differential and the fundamental scenario lying beneath. The Reserve Bank of Australia’s target overnight lending rate is currently 7.25%, reached 5 March 2008 after a dozen successive 25bps hikes initiated 5 December 2001. This was done, at least in part, in an attempt to curb rising inflation, which in June reached 4.5% y/y and is widely expected to rise even higher before coming under control.

The Bank of Canada, on the other hand, ceased tightening monetary policy on 10 July 2007 at 4.5%, went into a neutral stance until 4 December 2007, then initiated a brief series of rate cuts that culminated on 22 April 2008 at its current 3.0%. The timing, of course, was dictated by the subprime mortgage crisis within the United States, Canada’s largest trading partner. The general expectation was that slowing demand, should the U.S. fall into recession, would weigh on Canadian growth prospects and perhaps drag its economy down, as well, particularly as USD slumped against CAD, increasing the price tag of Canada’s goods.

In such a scenario, it’s not surprising that AUD rose strongly against CAD; however, that situation is changing. The high Australian interest rate seems to be biting, slowing consumer demand and easing the economy into a lower gear, while in Canada, although growth contracted 0.3% in 1Q2008, sustained high commodity prices, particularly for crude oil, have bolstered the economy despite the fall in overall net exports. With current market expectations of eventual RBA cuts set against the understanding that Canada cannot and need not cut further, the currency pair’s balance is shifting.

Whether the result is consolidation or reversal depends upon commodity prices. Should these continue to lower, as they have the past two weeks, AUD could slide against CAD and other major currencies; however, if the commodity top is not yet in place, resistance at 0.9836 may mark the upper level of a developing consolidation range