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  • Hedge funds are turning less pessimistic on the Canadian dollar while asset managers have turned bullish, in line with higher oil prices and Canadian equity outperformance.
  • However, caution is necessary. CME data on option strikes suggests downside demand for the Canadian dollar. The broad path for global commodities will prove critical for the Canadian dollar’s trajectory in coming months.
  • Meanwhile, the FX volatility curve using CME options data suggests investors are in “fear” mode.

The Canadian dollar is up 3.5% (vs USD) over the past three months, second only to the Norwegian krone. Oil prices are partly the cause. Brent crude escaped its $72-77/bbl range and headed back towards $85/bbl. This benefited the currencies of both oil-exporting nations. Meanwhile, the Bank of Canada tightened monetary policy at each of its last two meetings, having previously been on pause. The overnight cash rate now sits at 5%. As a result, investors pushed the Canadian dollar higher and outside its seven-month range.

Higher oil prices and tighter Canadian monetary policy have forced investors to adjust their previously bearish positions. Hedge funds have scaled back Canadian dollar net-shorts from 49.1k contracts a month ago to 11.1k (Chart 1). That is the largest adjustment in G10 FX over the period.

Meanwhile, asset managers have turned net-long on the Canadian dollar for the first time since early November (Chart 2). They are also increasingly bullish on the euro and pound. The yen is the only currency about which they are uncertain, with minimal net-shorts (1.4k).

Aggregating investor positions, we find hedge funds are quickly scaling back bearish Canadian dollar positions while asset managers have turned net-long on the currency. Meanwhile, hedge funds and asset managers are both net-long the euro and pound and both net-short the yen, the Swiss franc, Australian dollar, and the New Zealand dollar.

Macro Hive take: We are cautiously optimistic on the Canadian dollar. Global economic data is holding up, supporting commodity prices, while Chinese industrial demand appears to be encouraging oil prices even higher. Simultaneously, Canadian equities are outperforming as strong U.S. equity performance tires. Positioning flows are directionally positive, too. Therefore, the Canadian dollar could continue to outperform against the dollar.

Option strikes

The Canadian dollar is trading around year highs. To strengthen further, it must overcome the next obstacle: bearish FX options positions. According to CME data on option strikes:

  • There is notable net demand for CAD/USD puts from 0.66 to 0.685 – equivalent to bullish USD/CAD demand from 1.46 to 1.52 (Chart 3). Additionally, demand for puts persists up to the current spot price.
  • Bullish demand is strong, but only from 0.76 to 0.78 – equivalent to bearish USD/CAD demand from 1.28 to 1.32. Demand falters beyond there.

What to watch: the direction of global commodities still depends on global demand, especially Chinese demand. Supply from key OPEC+ players will remain critical, too. Meanwhile, sticky core Canadian inflation will support the Canadian dollar. Consequently, forthcoming inflation prints (15 August) will remain important.

FX investor risk appetite

CME has a range of FX volatility data to help investors track the level of volatility. We can also use FX volatility data to determine investor risk appetite. We find the shape of the FX volatility curve useful in this regard. When shorter-dated FX implied volatility is higher than longer-dated volatility, this suggests investors are worried or in panic mode. In contrast, when shorter-dated FX volatility is lower than longer-dated volatility, this suggests investors expect calm markets. The latest data finds:

  • The FX volatility curve is steepening, having retraced from its deepest inversion in over a year (Chart 4). Investors are less sure of a soft landing while central banks are keeping to their word, hiking more if necessary. This suggests investors are becoming more fearful.
  • The move aligns with the CME’s CVOL volatility indices, which have followed a similar dynamic, picking up from lows in June.
  • Outside FX, equity volatility has stabilised at historically low levels, while rates volatility remains historically elevated despite being pared from 2023 extremes.
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