A Loonie headache
Perhaps it’s these summer markets or true confusion that is creating a ticking time bomb in the Canadian Dollar. Either way, the currency appears at risk of significant volatility without the market pricing for it. Let’s have a look at recent developments in CAD, what’s coming up and why today’s price level is creating the opportunity for volatility. The Canadian Dollar has been rising over the past month. The major driver of that move has been the combination of the US Federal Reserve’s decision to hold rates in July coupled with a strong read in Canadian jobs data shortly thereafter. Fine, no problem there then.
Unfortunately, just prior to those two events, President Trump announced an August 17th deadline for 50% tariffs on some Canadian goods. That risk has been largely omitted from USDCAD spot, forward or options pricing. That deadline is rapidly approaching with a near-balanced risk that tariffs are either implemented or avoided. To add a layer of complication, the Canadian Dollar retains a price sensitivity to oil. Oil prices have also been at the mercy of the evolution of Trump‘s military offensive against Iran. If you’re starting to run out of fingers to count the competing forces within the Loonie, then you may be starting to see the problem.
With competing forces, let’s turn to the options market for a clue on directionality. Looking at risk reversals we see that the ‘skew’, the measure that can be amply used as a proxy of whether the market thinks the currency may go up or down, is almost as flat as can be in USDCAD. In itself that’s also not so much of a problem. However, when combined with the fact that, as of late last month, the Canadian Dollar is the most shorted currency out of the G10 basket, a risk opens up. Fine, you might say, surely implied volatility reflects this building risk and uncertainty in the Canadian Dollar? Wrong: implied volatility sits at multi-year lows in this currency pair. With the motive and the means in place for volatility within the Canadian Dollar, the last part of the drama outstanding is opportunity. On that note, there are more events due to take place in Canada’s political economy in the next week alone than in the entirety of the last month. With the stage set, all eyes will be on the Loonie this week.
Discussion and Analysis by Charles Porter
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