Commodity slumps, central banks’ interventions and their impact on USD/CAD valuations

BoC's unexpected moves: Majority of the recent adverse impact on CAD has focused on the interest rate dynamic as the BoC's unexpected rate cut. But shifting correlations raise another downside risk associated not with rate changes, but rather the outright low level of yields and its potential as a funding currency if risk appetite continues to improve.

Commodity slumps: The abvoe phenomenon is not unique to the CAD and MXN pairing; exactly the same underlying correlations drive CAD up the funding currency rankings for several other higher-yielding commodity linked currencies (notably AUD, NZD, and CLP). Ironically, when risk appetite was the overarching driver of FX markets for many years, this would typically have been a CAD positive environment. In addition to that citing a larger-than-expected H1 contraction and a puzzling stall in non-energy exports and massive drops in crude oils can't be disregarded for loonies' depreciation.

2-year US-Canada yield spreads: We are positively bullish on USD/CAD as the spreads have been one of the best depictions of the BoC/Fed deviation theme and this disparity should continue to trend in favour of a higher USD/CAD as the Fed approaches its first rate hike.

1M 25-delta risk reversals: USD/CAD bid for calls distorted after the BoC rate cut-helped by a similar move in other USD crosses and are currently hovering near the post crisis lows. After the move to 1.30, the options market appears to be more balanced on the direction for the pair over the 1m to 1y time horizon.