FxWirePro: USMCA, Italian yields and BoC – Centre of attraction of FX option markets

The new “USMCA” (United States-Mexico-Canada Agreement)deal (replacing NAFTA) has been announced last Sunday, that was greeted by the market as risk-benign, supporting the decline of FX vols (for EM and CAD in particular) as observed since mid- September, and allowing to put aside for the moment trade tariff concerns. 

Even though the Bank of Canada (BoC) never seemed overly fretful about an end of NAFTA it is nonetheless likely to have breathed a sigh of relief when the new USMCA deal was all sorted out. One risk less, apart from that everything seems to be going to plan for the BoC at present. The economy is humming, the unemployment rate continues to fall with moderate wage growth, as the recent labour market report on Friday proved, and the various measures of core inflation are in the middle of the target range. 

The overall rate on the other hand is almost touching the upper limit. That means the BoC can continue with its rate hike cycle. On 24th October, it will once again hike the key rate by 25bp to then 1.75%. 

However, this step is almost entirely priced in, so that this is likely to cause only limited up- side pressure for CAD. What will probably be more important is whether the BoC is planning to accelerate the cycle or to extend it. At least the market can now once again fully concentrate on this matter, now that the USMCA agreement has been reached, so that wage and price data in particular is likely to become more important for CAD once again. 

Canada can rely on important allies in the US: in Congress, where all trade agreements have to be ratified, resistance is forming against an agreement between the US and Mexico, excluding Canada. This strengthens the Canadian negotiating position but also increases the risk of a possible failure of the negotiations. The resulting risk premium is putting pressure on the Canadian dollar. 

Contemplating above factors, debit call spreads are advocated as the buying indications are piling up in near-terms. 

Execute strategy by buying 2m (1%) in the money 0.69 delta call option and short 2m (1%) out of the money call option for net debit. The strategy can be executed at net debit.

Thus, shorting an out of the money call option is recommended to reduce the cost of hedging by financing long position of in the money call option. 

Over the past week, market attention shifted again to Italy as the Italian government announced a higher- than- expected budget at 2.4% for the next three fiscal years, which triggered a sell-off of Italian bonds.

As a second hedge against higher Italian yields, we
focus on a carry-friendly long EURSGD / short
USDSGD 2M vol spread, which would benefit from
lower EUR and higher EUR vols. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly CAD spot index is inching towards -80 levels (which is bearish), hourly USD spot index was at 121 (bullish), while articulating (at 12:03 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex