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FxWirePro: Can BoC join doves camp in H2’2019? Need for hedging as USD/CAD wedged between monetary policy and geopolitical risks

USDCAD is looking little weaker despite the fact that last month, the BoC formally eliminated its rate hiking bias. This has staged for a range of risks from trade to oil to feature more prominently this year. The BoC, along with its US counterpart, is now indefinitely on hold. But on the flip side, Fed has also indicated hiking cycle, the hurdle is that it seems, for the Fed to not provide an insurance rate cut seems high.

Bank of Canada is on the table for its monetary policy at the beginning of H2’2109 (scheduled on July 10th). 

In completing its dovish turn, the Bank made a number of notable revisions to its outlook to adjust for both serially underperforming potential growth as well as risks by revising down: 1) the range of neutral interest rate estimates and 2) 2019 real GDP (by a half-point to 1.2%, well below potential at 1.8%).

Despite the seminal shift in policy, US-CA rate spreads have actually compressed by almost 15 basis points since the BoC meeting, following concerns on US inflation and global trade. Even with both the Fed and BoC on hold, somewhat tempering volatility in relative monetary policy expectations, we view scope for potential re-widening in the relative spreads given the recent relative growth dynamics between the two countries. 

Not only is US relative growth outperformance persisting, but it would appear that this growth differential is currently being somewhat discounted in rates markets (refer 1st chart). Should this relative outperformance continue, a rewidening of US-CA spreads may be justified, and would be supportive of USDCAD higher, OTC FX positionings are also indicating the same thing.

In communication so far this year, Gov. Poloz has been quite vocal in stressing the drag from ongoing international trade tension and uncertainty on the Canadian economy, and from US-China in particular (the BoC actually revised the estimated drag on global growth from US-China trade tension higher in the April MPR). Renewed China trade tension has the potential to exacerbate negative trade outcomes and further limit business investment in Canada, cumulatively threatening to drag on growth (refer 2nd chart). While the Bank has signaled its intent to remain on hold in 2019, further slowdowns in trade and investment would threaten the Bank's expected 2H growth rebound, and if realized could warrant pricing in more odds of future cuts. Given that this new reigniting of trade tension was not baked into BoC’s April MPR expectations 

On hedging grounds, at spot reference: 1.3172 levels, contemplating above technical factors, we advocate initiating shorts in USDCAD futures contracts of July’19 delivery as further downside risks are foreseen and simultaneously, longs in futures of August’19 delivery for the major uptrend. Thereby, one can directionally position in their FX exposures. The directional implementation of the same trading theme by further allow for a correlation-induced discount in the options trading also if you choose strikes appropriately.

Alternatively, at spot reference: 1.3160 level, one can also buy 3m ITM call (with strikes of 1.3070). Such options with strike prices close to the price of the underlying spot tend to have the highest risk premium or time-value built into the option prices. This is compared to deep in the money options that have very little risk premium or time-value built into the option price.

Thereby, one can achieve hedging objective as the deep in the money call option with a very strong delta will move in tandem with the underlying spikes. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly CAD spot index is inching towards -11 levels (which is mildly bearish), USD is at -31 (mildly bearish), while articulating (at 11:17 GMT). 

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex

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