FxWirePro: GBP/CAD driving forces and hedging setup

The BoC and the BoE appear to be looking to normalize monetary policy but experiencing similar difficulties. Both are involved in uncertain trade discussions that are weighing on investment and both have seen a softer patch of data than the market originally expected. Given it strips out the USD component and has similar risks to the front-end pricing, perhaps GBPCAD is an RV trade worth considering.

Canada’s deteriorating credit growth and soft retail sales have led to short CAD becoming a consensus position and well reflected in the low valuation of CAD, in our view. While Governor Poloz was considered to be dovish by the market, he was still discussing in his recent speech the need for higher interest rates. It would likely take a severe shock to the GDP numbers tomorrow to offset that. Meanwhile, oil supply concerns after the OPEC meeting are leading to an improvement of CAD’s terms of trade that we expect will continue and should see CAD become more supported.

GBP, on the other hand, faces another political test next week with the Cabinet’s Chequers away day designed to decide on the long-term Brexit policy. The Cabinet is still very divided and the talks are likely to lead to further political tensions, potential resignations and leadership concerns that should weigh on GBP.

One big surprise of the trade war rhetoric has been the risk off we’ve seen in markets being driven more by the rise in oil and USD strength rather than trade actions. That is then followed by the disconnection between the underperformance of commodity currencies (e.g., CAD) and the improvement in their terms of trade owing to higher oil.

In our opinion, CAD rates pricing was one reason for the underperformance; there was simply too much priced in the belly of the curve in a fashion similar that was too close to US rates pricing. Then there is the impact of the US tax reform that has led to increased M&A outflows.

Option Strategic Framework:

Please be noted that the positively skewed IVs of 1m tenors of this pair is well balanced on either side, technical trend (both minor & major) and above stated fundamental driving forces of this pair have been indicating perplexities which means hedgers’ sentiments of this pair may head towards any directions with more potential on downside in near term.

Accordingly, we advocate below options strategy that is likely to optimize hedging motive.

Strategy: 3-Way Options straddle versus OTM call
Spread ratio: (Long 1: Long 1: Short 1)

How to execute: At spot reference: 1.7374, initiate long in 1M GBPCAD at the money +0.51 delta call, add one more lot of 1M at the money -0.49 delta put and simultaneously, short 1w (1%) out of the money call with positive theta. The short leg with narrowed expiry (lower side) likely to reduce total hedging cost. Courtesy: Nomura

Currency Strength Index: FxWirePro's hourly GBP spot index is at shy above 127 levels (which is bullish) on prints of encouraging UK service PMIs (actual 55.1 versus consensus and previous 54 levels), while hourly CAD spot index is edging higher at 63 levels (bullish) while articulating (at 12:13 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex.

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