FxWirePro: CAD hedging bids seem tepid despite lingering hopes of BoC hikes – Deploy short hedge with short-term tenors

The reasons for a rate hike on the part of the Bank of Canada (BoC) in two weeks’ time cannot be ignored.

But the inflation data for May published last Friday briefly rocked the market as it was slightly weaker than expected so that the CAD eased briefly. The overall inflation and the different measures of core inflation are comfortably at the centre of the BoC’s target range and the inflation trend too does not leave much to be desired.

While the unemployment rate has reached historic lows and the business survey for Q2, due for publication today, is likely to confirm the image of dynamic economic activity. A thick, dark thundercloud remains on the economic sky though: the NAFTA negotiations and the concerns about an escalating trade conflict. There is quiet on the NAFTA front following the introduction of tariffs on steel and aluminium imports and the tough language between the two heads of government, as Trump is focusing mainly on China, technology and cars now and has since identified all nations trading with the US as enemies.

Next week the Canadian representative in Washington will meet the finance ministers of the Canadian federal states, the US diplomat in Canada as well as some high-ranking representatives of Canadian companies and central bank governor Stephen Poloz in Ottawa.

This illustrates the lingering concerns the Canadian leadership has about further developments in the trade conflict.

While a rate step by the BoC in July is priced-in at 2/3rd, that credits to be given for the US and China. There is still a residual risk that the BoC will wait despite all the positive aspects of the domestic economy before resuming the rate hike cycle. However, we think that the BoC will take action in July and that CAD will be able to appreciate.

Please be noted that the risk reversals of USDCAD for short-term tenors are showing minor changes (changes only in 1w expiries), while bullish hedging bids remain intact for the long-term. While the IV skews are also positive for 1w tenor is slightly stretched out for OTM puts, while the 3m IVs are still positively skewed which means bullish risks remain intact despite the above stated fundamental factors. While 1w forward rates show negligible changes and bearish targets in the longer tenors.

Hence, we advocate staying short in 1w USDCAD forwards with a view to arresting potential bearish risks in the near-term and longs in 3m forwards. Courtesy: Commerzbank

Currency Strength Index: FxWirePro's hourly CAD spot index is flashing at 145 levels (which is highly bullish), while hourly USD spot index was at -5 (neutral) while articulating at (14:00 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex

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