Macro and Vol Commentary
The Canadian dollar has been sold against the US dollar for the majority of September, highlighting America’s economic strength. With the currency pair finding resistance at 1.40, what is next for USDCAD?
Economic Outlook
- Canada’s growth, in line with other developed nations, saw a slower pace of growth in recent months.
- GDP for September grew by 4.0%, down from 4.4%, the third consecutive monthly decline since the peak of 5.54% in May.
- Solid grain crops helped carry the economy better in the last quarter.
- However, even with continued softening, the government acknowledged that it might be on the optimistic side.
- We expect Q4 to come in even lower and possibly stall, but the recession is not yet imminent, and growth is likely to follow suit with the US.
- The numbers show inflation and higher interest rates did not yet derail economic activity over the summer, but the economy is clearly slowing down.
- Retail sales dropped by 0.5% m/m, erasing much of a 0.7% jump in August.
- The gain was largely led by sales in grocery and autos as households enjoyed the higher level of disposable income from lower energy prices.
- Still, retail sales will continue to edge lower on a year-to-year basis as the remainder of the buffer funds diminish, and consumers take out fewer loans to finance these purchases given high interest rates.
- Likewise, manufacturing performance continued to contract, with the latest figure for October at 48.8
- This is falling slowly further into the pandemic lows, as output and new orders fell concurrently and for the fourth month in a row.
- Likewise, CFIB Business barometer index is falling steadily, with the latest decline pushing it to 51.4.
- CPI, in line with other developed economies, continues to remain elevated, although we expect that on a year-to-year basis, the prices have peaked.
- The October figure came in at 6.9% y/y, while down from 7.0%, it still remains at 40-year highs, confirming the upward stickiness of inflation.
- Indeed, sources of pricing pressures have shifted from energy to components that the consumer feel directly: food, shelter, and household items.
- Core CPI grew by 6.0%, down from 6.3% in July.
- PPI, after months of softness, is showing signs of building up the pace again, with industrial product price growing by 0.1% m/m after a 1.2% decline in August.
- Indeed, raw materials prices were recovering in recent months, up from -4.2% to -3.2% in September.
- This could once again create pressures on producers to pass down the costs to consumers, prolonging the impact of inflation.
- On the other hand, Canadian labour might remain tight and shows no signs of easing.
- The unemployment rate remained unchanged at low levels of 5.2% in October, another sign of tight labour market conditions.
- Moreover, the participation rate has improved to 64.9%, up from 64.7% in September, June highs.
- The overall net change in employment equalled 108.3k, the sharpest rise since March 2022, and marks a 10-fold gain over market estimates.
- Much of the employment change was led by full-time increases, up by 119.3k during the month, while part-time employment fell by 11k m/m.
- The hourly wage jumped by 5.5%, the fifth consecutive month of growth of above 5.0%
- Workers in construction, professional services, accommodations and food saw even bigger gains than that.
- This shows a similar story to the US, where the wages are becoming sticky, and on a real basis, earnings are diminishing in the face of elevated inflation.
- This is putting further pressure on the BOC to continue hiking rates into the start of 2023.
- We expect the labour market to remain overheated and show signs of cooling once the number of vacancies begins to drop.
- Another sector showing resilience in the face of slowing growth is trade, in particular, the merchandise trade surplus widened unexpectedly in September as exports of wheat and crude oil rebounded.
- The surplus rose to C$1.1bn, confirming that international demand for Canada’s exports remains solid, even amid mounting global economic headwinds. It could help to offset some weakness in other parts of the economy as activity stalls in coming quarters.
Bank of Canada
- In October, the BOC hiked the interest rate by 50bps, vs the expected 75bps
- While this has created downside pressure on the CAD, the 75bps was out of the ordinary for the central bank, which has been hiking interest rates by 50bps since the start of the year.
- Indeed, Canada’s central bank had been boosting its key rate since July, when it increased by 100bps, a magnitude others hesitated to implement.
- Now the officials have stated that the hiking cycle is approaching its end, even though more increases are coming.
- Still, while the investors have downgraded their outlook for near-term rates given the surprise 50bps hike, the continued pricing pressures, especially those coming from wages, lead to an upgraded the hiking peak of 4.5%, up from 4.25% seen after the BOC decision.
- The next meetings are taking place in December and January, and the forward swaps are pricing in a 35bps hike followed by 30bps.
- Moreover, if the wage growth remains above 5.0%, we expect the markets to price further tightening from the CB.
The indicators of Canadian manufacturing performance and overall business confidence are falling deeper into the contractionary territory, as the probability of recession in the next 12 months increases. And while the lows are not on par with the lows we have seen during the pandemic, the gradual decline points to a prolonged deterioration in the economic performance across the board. In addition, the surprise 50bps hike in October has removed some of the confidence in market expectations from BOC future decisions. In the US, on the other hand, Jerome Powell’s statement solidified the expectations of a continued pace of hiking, albeit at a slower pace, without indicating a pivot. A 50bps from the Fed in December should drive the USDCAD lower on the day; however, we expect the dollar strength to prevail in the medium term, even if the BOC chooses to increase the scale of the next rate hike once again in the face of higher inflation.
Sources: Canada Mortgage and Housing Corporation, STCA - Statistics Canada
Volatility Commentary
We’ve recently seen a slight reversal in USD strength over the last few weeks with FX Macro Vols also slightly coming off. As we go into winter with energy costs being a major concern for Global economies we generally see potential for USD strength to return, however we see CAD to potentially buck this trend with Canada being a major energy exporter. Below we suggest a deal benefitting from USDCAD heading lower in the medium term.
USDCAD 1-month Implied vs Realised Volatility
USDCAD Trade Idea
- Idea 3 month expiries
- Buy USDCAD European Digital, 100k USD pay out for spot below 1.3100 at expiry – Pay circa 24k USD
- Sell USDCAD Vanilla Call Spread with strikes 1.3600 & 1.3800 in 5m USD notional – Receive circa 24k USD
- Net structure circa flat premium
Positioning Charts
USDBRL NDO Positioning Data 25/10/2022 - 01/11/2022
Options in the week of November 8th showed appetite has reduced quite a bit. We saw fewer calls and puts traded then and the range tightened into 4.60-5.50 from 4.60-6.20 in the week ending November 1st. Both have little cover on upside and downside and momentum for the spot is now lower on the downside. However, little conviction surrounding these levels could suggest a slowdown in recent momentum.
USDBRL NDO Positioning Data 01/11/2022 - 08/11/2022
USDCNY Vanilla Positioning Data 25/10/2022 - 01/11/2022
Options executed in the week to November 1st showed ample appetite for options, with the number of calls exceeding the puts. Options due to expire by the end of this year have reduced in number and in size, and traded in a tighter range for expiries in November, at 7.10-7.70. The range widens out significantly after that. Likewise, the volume in the week ending November 1st saw lower number of positioning take place, especially for expiry into next year. The market has lost some conviction but there is still a moderate favour to the upside.
USDCNY Vanilla Positioning Data 01/11/2022 - 08/11/2022
USDCAD Vanilla Positioning Data 08/09/2022 - 08/10/2022
Options executed in the month to November 8th, are more concentrated than the previous month, with the range tightening into 1.30-1.50 into the year-end and there is now less downside bias, with fewer puts being executed in the next couple of months. The number of call options also reduced and the upper range has remained intact at 1.60. Options executed continue to cluster around 1.37 but option notional are bigger, suggesting greater conviction despite lower overall market appetite.
USDCAD Vanilla Positioning Data 08/10/2022 - 08/11/2022
Charts and Tables
FX Expiries
Volatility Grid
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Weekly Change
Key Events & Releases
Technical Analysis
JP Morgan Global FX Volatility
The index continued to edge higher yesterday, back above the support level of 110 to close at 110.53. The stochastics are seen rising, with %K/%D in the overbought and diverging. The MACD diff is positive and diverging on the upside, supporting the outlook for a continuation of bullish momentum. On the upside, the break above 50 MA at 111.07 could set the prices to test the 100 MA at the 111.33 level. Conversely, to confirm the outlook for lower prices, the index needs to take out the 110 support, which would signal a strong bearish momentum. At the same time, the moving averages are capping the prices on the upside; however, we expect the dollar to test these levels in the near term.
Dollar Index
The index has been softening in recent sessions after finding resistance at 50 MA and has been trading mostly sideways today, supported by 11.39. The stochastics have, however, converged on the downside once again in the oversold, confirming a strong selling pressure, and the MACD is negative but struggled to point out a conviction. If weakness prevails, we could see prices break below the 11.39 level to test 11.11. On the upside, if support above this level holds firm, this could trigger gains through 50 MA at 11.81 and target 12.00. The stochastics suggest we could see the index fall further in the near term, but the index needs to breach the near-term support to confirm this.
USDCAD
The pair weakened so far in November, and that weakness brought the pair back down below the moving averages. In recent days, however, the pair found support at 1.33 and edged higher to settle at 1.35. The stochastics are diverging on the upside, with %K/%D now entering the overbought, and the MACD diff is positive and diverging, suggesting growing rising pressures. A breach of moving average resistance levels, in particular, the 50 MA at 1.3574, may prompt the bulls to target the 100 and 200 MAs at 1.3619 and 1.3673, respectively. Alternatively, the reaffirmation of resistance at 50 MA could trigger a break below the 1.33 level once again would help to confirm the bearish momentum. The most recent gains have stalled today as prices struggled above the near-term moving average support, and we expect these levels to cap the upside in the near term.
