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Beyond the unwind of the earlier premium versus a heavily broadly discounted dollar as discussed earlier, the other major driver of the 7% trough-to-peak backup in USDCAD in 1Q was the divergence of policy pricing between the Fed and the BoC, wherein US-CA 2y swap spreads widened by as much as 28bps between early Feb and late March, which on our model would have been worth half of the 7% backup in USDCAD.
As with CAD risk premium as discussed above, there are other plausible reasons for a pricing in of a relatively more dovish BoC, including the run of negative data surprises in 1Q. But it is hard to divorce NAFTA risks from the BoC pricing outlook, particularly given that it has been part of BoC’s framework and rhetoric for the past year, particularly since October.
Meanwhile, despite recent data surprises, our economist have not changed their expectations for 4 BoC hikes this year, in-line with the Fed, given ongoing indications that inflation is at/above target and capacity is tight even in light of some near-term softening in activity.
Finally, while the widening of US-CA rate spreads might be more justified given relative US-CA data surprises, the recent evolution in the data has been less differentiated versus rest-of-world economies, which again point to the recent relative underperformance of CAD on the crosses more compelling to fade (refer above chart).
We think there is medium-term value in fading the wide CAD underperformance and discount that has opened up recently versus peers, which in our baseline is not justified by relative monetary policy (4 BoC hikes this year), nor trade risk (no NAFTA crash-out). The potential near-term NAFTA break-through is a potential catalyst for the recent retracement of this underperformance to run significantly further. Therefore we buy CADJPY (bought at 85.195, stop at 83.0590) as a best risk-reward expression of CAD underperformance reversal.
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