Traders prepare for a weaker Canadian dollar as there’s likely interest rate cuts
Traders are bracing for weakness in the Canadian dollar amid wagers that local policymakers will likely reduce interest rates before their peers at the U.S. Federal Reserve.
That rate differential — which some on Wall Street expect to widen when the Bank of Canada meets on Wednesday — is already fueling one of the worst performances among Group-of-10 currencies this quarter. The loonie has been the second-weakest performer in the Group of 10 since the end of March, trailing only the Japanese yen.
“The BOC will deliver a cut which will weigh on the Canadian dollar,” said Elias Haddad, a senior strategist at Brown Brothers Harriman. He — like many on Wall Street — expects the Canadian central bank to reduce rates soon, while data in the U.S. may force Fed officials to keep rates higher for longer.
For many currency traders, that means the loonie is likely to keep slipping against the greenback, regardless of whether a Canadian rate cut comes in June or July. The market is pricing in around an 80 per cent probability of a cut on Wednesday, a jump from about 60 per cent odds implied before last week’s weaker-than-expected reading of Canada’s gross domestic product.
Asset managers and hedge funds have kept their wagers against the loonie near a seven-year high, only slightly trimming the positions, according to recent Commodity Futures Trading Commission data.
“Even if a rate cut does not pan out next week, the Canadian dollar is unlikely to see a sustained near-term rally,” said Howard Du, a foreign-exchange strategist at Bank of America Corp. “The BOC communication or guidance next week would likely remain dovish as the BOC looks to lay the groundwork for a July rate cut.”
A slew of technical signals are also raising alarm bells. One-week option volatility, a tenor that also incorporates U.S. and Canadian jobs data this week, touched 6.07 per cent Tuesday, its highest level in more than a month.
Over the past week, turnover on U.S.-Canadian call options have outpaced bearish puts by about three-to-two amid the growing odds of a BOC rate cut, according to Depository Trust & Clearing Corporation data. Of the calls traded, 20 per cent are strikes set at or above 1.40 — a level of weakness the loonie last breached in 2020.
While traders are still aggressively shorting the Canadian dollar, “unless there is new or additional motivation to extend shorts even further,” there’s a limit to how much it falls even in the event of a rate cut, according to Shaun Osborne, chief FX strategist at Scotiabank, one of the few holdouts in favor of a hold.
Citi economist Veronica Clark also expects a hold this week. “The U.S. experience of a pick-up in inflation after six-to-seven favourable months could be a particularly cautionary tale against premature cuts,” she wrote in a note to clients Monday. “We continue to expect the first rate cut in July.”
Some proponents of a June cut see the loonie regaining some of its strength later this year, when a potential Fed cut stands to reduce the differentials with the BOC’s rate.
BofA’s Du sees the loonie strengthening to 1.35 against the greenback by year-end with U.S. inflation and growth data continuing to follow Canada lower. “The Canadian dollar should rally more meaningfully against the U.S. dollar once Fed rate cuts become more imminent.”
This article was first reported by BNN Bloomberg
