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After a particularly gruelling week last week, G10 cyclical currencies rebounded this week (in still-illiquid conditions) to retrace over 5% vs USD on average. CAD, however, was a notable laggard, improving only 2.4% against the dollar.
This to us reflects an increasing awareness of Canada’s precarious economic situation, above and beyond the indiscriminate carnage that COVID-19 is laying upon countries worldwide. This was highlighted more clearly this week when Suncor, a large oil-sands producer, opted to temporarily shut down some production in the wake of local oil prices dropping to single digits. This is one of the key macro risks specific to Canada that we've been flagging, and is suggestive of particular pain in coming months on top of the likely huge contraction in the services sector. Canada’s current account deficit meanwhile is large but the basic balance remains negative, meaning that a deep or extended contraction could see a drying up of financing flows.
Given these concerns, it makes sense that CAD has decoupled from oil this week as the focus on Canada's specific weaknesses grows larger (refer 1st chart). Despite the move lower in USDCAD this week, we maintain that directionality from here is higher in the pair.
Hence, add longs in USDCAD via options contemplating above fundamental factors and below OTC indications:
The fresh negative bids are observed to the existing bullish risk reversal setup that indicates the mild price dips, while the hedging sentiments for the upside price risks (refer 2nd chart).
While the positively skewed IVs of 3m tenors are indicating the upside as well as upside risks (3rd chart).
Hence, at this juncture (when spot reference: 1.4134 level), we upheld our shorts in CAD on hedging grounds via 2-month (1.3920/1.4350) debit call spread. If the scenario outlined above unfolds, we will re-assess our stance but at the moment there are no changes to our CAD recommendations. Courtesy: Sentry, JPM & Saxobank
