FxWirePro: Preview of BoC and Portfolio Reassessment of CAD Derivative Trades

USDCAD is looking little weaker despite the fact that last month, the BoC formally eliminated its rate hiking bias. This sets the stage 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). 

We reiterate that global trade headwinds are suddenly gusting stronger and pose distinctly-negative risks to CAD. Despite the seminal shift in monetary policy, CA rate spreads have actually compressed somewhat since the BoC meeting, following concerns on US inflation and global trade.

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. 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. 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: 1.3070 levels, contemplating above factors, we advocated 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, we now like to uphold the same positions. 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, one can also buy 3m ITM call (with strikes of 1.30). 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.

Currency Strength Index: FxWirePro's hourly USD spot index was at -25 (mildly bearish), CAD is flashing at -81 (highly bearish), while articulating at (08:32 GMT). 

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