FxWirePro: Waning crude outlook & improving cyclicals to puzzle Loonie’s prospects

In May, CAD appreciated over 2%, retracing more than half of late April sharp sell-off.  In part, this triggered by the broad USD sell-off that unfolded following weak data and the emergence of US presidential scandal risk.  But it also came as concerns over housing market risks (which played a major role triggering the earlier selloff) faded while CAD short positioning peaked out (refer above figure).

In these pages last month we flagged that although housing market risks was an ongoing medium-term vulnerability, they were not yet acute and the idiosyncratic issues behind one mortgage loan company were unlikely to cause a broader fallout.

Post-retracement, CAD is looking more fairly valued, if not slightly expensive. Where the earlier selloff had looked to have overshot on the weak-side by as much as 1.6%, post-retracement, CAD is now screening 1.2% expensive on short-term fair value models.  This is largely because it was insensitive to the 12% decline in crude oil prices, which all things equal should have been worth 1% weaker in CAD. 

However, also helping offset a weakening impulse from oil prices was the fact that BoC is finally starting to rotate away from its dovish stance it had held for the better part of the last year, first the May monetary policy statement, and in yesterday’s Financial Stability Review press conference.

Use options spreads and combinations to tackle this pair as shown below:

Long 2m USDCAD 1.3280-1.3680 call spread; sell 1m 1.29 put.