- Leveraged funds have turned heavily bearish on the Canadian dollar. Meanwhile, asset managers have pared net shorts, though they remain bearish.
- We think net positioning can trend even more bearish, with the Canadian dollar unlikely to outperform the U.S dollar over the medium term. CME Group data on option strikes suggests USD/CAD could trade as high as 1.50.
- The FX volatility curve using CME Group options data suggests investors are in ‘calm’ mode.
The Canadian dollar has whipsawed within a 5% range this year. Frequent cases have been made for both strength – for example, it appreciated +2.5% against the dollar in June – and weakness. Since its summer high, the Canadian dollar has weakened nearly 4% against its U.S. neighbour. The reason for this was unfavourable repricing of two-year yields in Canada versus the U.S., as markets take resilient U.S. growth and “higher for longer” rhetoric to mean a smaller likelihood of U.S. interest rate cuts. Meanwhile, a recent collapse in oil prices has let the Canadian dollar weaken further.
This poor run of fortune has prompted hedge funds to reposition more bearishly: They closed 31.2k long Canadian dollar positions and opened an additional 10.4k short positions over the past month (Chart one). No other currency has seen a larger bearish revision over the period, making the Canadian dollar the currency hedge funds are most net short bar the yen. Hedge funds also added to euro net shorts and flipped net short on the Australian dollar.
Asset managers are less bearish on the Canadian dollar, however (Chart two). They have added 4.2k long positions and closed 43.8k short positions. They remain net short. Yen and Australian and New Zealand dollar net shorts saw similar revisions.
Aggregating investor positions, we find hedge funds and asset managers are both net short the yen and the Australian and Canadian dollars. They disagree everywhere else, including on the euro.
Macro Hive take: We see little reason to chase Canadian dollar strength against the U.S. dollar. While near-term oil prices could offer upside to the Canadian dollar, demand will likely falter through H1 2024 as further production comes online. That means the commodity case is weaker than it appears. Elsewhere, we expect the U.S. dollar’s positive carry story over the Canadian dollar to continue and expand; another BoC hike remains a risk, but loose U.S. fiscal policy, resilient household balance sheets, and stubborn U.S. core inflation mean the Fed could tighten policy above 7%. In that scenario, we could see USD/CAD trading towards 1.40.
The Canadian dollar has traded near year lows in October while some investors are positioned for a Canadian dollar making fresh year lows. According to CME Group data on option strikes:
- There is notable net demand for USD/CAD calls from 1.36 until 1.40 (Chart three). Thereafter, demand falters before accelerating above 1.50. This means investors need USD/CAD to trade above those levels to register a return on their call options.
- Bearish demand is less extreme, however, despite being present from 1.35 down to 1.23.
What to watch: the direction of the Canadian dollar still relies on oil prices and central bank decisions. The Israel-Hamas conflict could influence oil prices if it spreads through the region. Meanwhile, markets are unsure of Fed policy, ascribing just a 30% likelihood of a December hike, according to FedWatch. Labour market tightness (November 3) and core inflation (November 14) will be key determinants.
FX investor risk appetite
CME Group 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 continues to flatten towards summer lows, having been steep only momentarily earlier in the summer (Chart four). This suggests investors are becoming surer that a soft landing is possible and are calmer.
- The move aligns with CME Group CVOL volatility indices, which have followed a similar dynamic, trading near year lows.
- Outside FX, equity volatility remains historically low, while rates volatility has resurged as long-end yields caught markets wrong-footed.
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