Macro and Vol Commentary
With the BOC becoming one of the first major central banks to hit a pause on interest rates, all eyes are on what the divergence between the BOC and other central banks will bring for the USDCAD.
- Canada's economic picture is quite mixed, with signs of a rebound in the consumer sector while the housing and the business segments continue to deteriorate.
- GDP came in flat in Q4'22, far below the forecast of a 1.6% annualised rate, with business investment declining by 5.5%.
- The housing market data pointed to a continued decline in home prices in February, at -1.1% m/m.
- Inflation path in Canada has been similar to what we have seen in other developed countries.
- The decline in pricing pressures accelerated in H2'22 and continued to decline slightly into 2023.
- Both overall and core inflation eased in February to 5.2% and 4.8% y/y, respectively.
- While the yearly deceleration was partly due to the high base of last year, food, shelter and transportation posted slower gains, at 0.6%, 0.2%, and -0.4% m/m, respectively.
- Inflation softness is bolstering the case for keeping the rates steady for now.
- The central bank expects headline inflation to fall to 3.0% by midyear; this will mark a 220bps fall from now on, the decline that took seven months to materialise until now.
- Another sign of strength is coming from the labour market, which pointed to healthy job gains.
- The economy added 21,800 jobs in February, yielding a total of 20.1m employed.
- However, this increase was one of the slowest since September.
- The unemployment rate reached 5.0%, near a record low, as the number of employees grew in the private sector.
- Persistent tightness in the labour market is adding pressure to worker compensation, with wages increasing to 5.4% in January, the highest since November.
- In February, total hours worked rose 0.6% m/m and up 1.4% y/y, adding to evidence of sustained productivity momentum in Q1'23.
- With that in mind, we expect inflationary expectations to drive the rhetoric for the upcoming CB meeting, as labour market figures show no signs of abating.
- The economy added 21,800 jobs in February, yielding a total of 20.1m employed.
BOC vs Fed
- The BOC left the key rate on hold in early March at 4.5%, the first unchanged move in nine meetings.
- This comes as a sharp contrast to the Fed and other major central banks that have chosen to continue with the monetary policy tightening.
- Weeks ago, this would have pushed the bets for the CAD to hike again in April to catch up with the Fed; however, given the unravelling banking crisis, markets now see fewer moves for all major central banks.
- This should lessen the downside pressure on CAD as both the Fed and the BOC converge in their monetary policy outlook over the longer-term period.
- The terminal rates for both nations are being priced in at 4.90% and 4.45% for the Fed and BOC, respectively.
- At the same time, the case for a cut has increased, with 42bps and 37bps worth of cuts priced in by the year-end, respectively.
- We expect markets to increase the probability of a rate hike for the Fed in May, and even if the policymakers do not hike, this could push CAD lower in the near term.
Central bank divergence is now the key driver of FX pairs. While risks remain skewed to further hikes, we do not expect tightening from the BOC in the near term; the Fed outlook remains uncertain. Swaps pricing for the BOC show one more hike at some point within the next few months, but for the next couple of meetings, at least, they are likely to pause. Our base case for the dollar remains that of resilience: the dollar remains the safest currency, and the Fed's higher-for-longer terminal rate outlook and a possibility of further tightening in May should provide support for the index. We expect the support at 100 to remain intact. The near-term outlook for USDCAD is that of marginal upside, as we expect markets to increase the hiking bets for the Fed following calming banking sector outlook, supporting the pair at 1.35 (1 month). Over the longer term, the two central banks' paths are set to converge as both pause the rate of hikes, and we expect a marginal downside for the CAD to drive USDCAD back to 1.30, given the weaker position of the Canadian economy, especially into H2'23. Exposure to the China story also makes it vulnerable to slow recovery; we do not expect CAD to be at the forefront of a rally.
Sources: S&P Global, STCA - Statistics Canada, Bank of Canada
At the start of January we saw a sharp realisation of volatility, that persisted till the end of the month. By the February volatility sharply dropped by 3 VOLS and continued edging lower. One interesting observation, since beginning of March, the 1 month IV seems to have low correlation to the 1 month Realised Volatility, this is clearly highlighted when IV increased by almost 3 VOLS from the beginning to mid March, while RV remaining the same without changing levels. From a vol perspective, the market is overpricing implied volatility hence you’ll be paying higher premiums for being long options. One play is to sell vol and collect Theta, this strategy would have been profitable if executed in the past two months, however the risk is, as we can see in the historical volatility chart, volatility tends to shift aggressively by a big magnitude and if you are short gamma during that period then you may get caught in a very bad position.
Despite the higher current premiums, given that USDCAD has been trending lower, a EKI Put can be a way to be gamma hedged with a view that in the next 3 months we are betting that there will be a spike in realised volatility.
USDCAD 1-month Implied vs Realised Volatility
USDCAD Trade Idea
- European Knock In Put Option
- Strike: 1.3526, KI barrier: 1.325
- Expiry: 3 months, 31/03/2023
- Notional: 10M USD
- Pay Circa 118k USD
- Potential payoff: Circa 275k
USDBRL NDO Positioning Data 16/03/2023 - 23/03/2023
USDBRL option positioning saw the range down the far end of the curve tightened, with more positions being brought forward in the expiry taking place in April. The size of the notional suggests a continued lack of appetite out of the current ranges, highlighted by an equal amount of calls and puts. The near-term range is now at 5.00-5.50, and there is a slightly better conviction for the 5.25 level. The number of calls is seen building further down the line, with option expiries at 5.45-5.40 in mid-April. We expect to see sideways trading before marginal momentum on the upside.
USDBRL NDO Positioning Data 23/03/2023 - 30/03/2023
USDCNY Vanilla Positioning Data 16/03/2023 - 23/03/2023
The number of positions for USDCNY reduced in the week trading March 30th, given the expiries that already took place from mid-March. Both upside and downside covers extend to 7.10 and 6.70, respectively; however, the smaller size of the notional suggests a lower appetite for these levels. In the near term, option expiries point to a tighter range of calls than puts, suggesting markets might see 6.90 as a key level for upside conviction. This is then further extended into April.
USDCNY Vanilla Positioning Data 23/03/2023 - 30/03/2023
USDCAD Vanilla Positioning Data 30/01/2023 -30/02/2023
USDCAD expiries saw the near-term range shift from 1.33-1.38 to 1.35-1.41, highlighting some upside momentum in the month ending March 30th. A heavy amount of puts and calls for April and May expiry points to a strong market appetite for currency moves; however, an equal number of positions on both ends suggests a lack of directional view in the near term. There is a bigger appetite for positions taking place down the curve, and we suspect this is taking place as markets assess the longer-term divergence between central banks' monetary policy moves.
USDCAD Vanilla Positioning Data 30/02/2023 - 30/03/2023
Charts and Tables
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Key Events & Releases
JP Morgan Global FX Volatility
The index continued to soften in recent days breaking below the support of 10.66, and is now seen edging back to 10.50. At the same time, a breach of short-term moving averages highlights the downside conviction in recent days. The indicators, however, point to waning downside pressures: %K/%D is about to converge on the upside in the oversold, and the MACD is negative and flat, following recent downside pressures subsiding. To confirm the acceleration of the upside trend, the index needs to break above the moving averages of 10.75 before testing 11.00 once again. Alternatively, if the index was to break back below the 200 MA at the 10.45 level, we could see levels retest at 10.17 and 10.00, the March low. The indicators point to a build-up of upside momentum in the near term, but we expect the index to remain capped by moving.
The index continued to soften in recent weeks but found support at 102.00 and has traded slightly above it since. The indicators point to a strong buy signal: the %K/%D has converged on the upside and is now rising out of oversold. MACD diff is negative and is about to converge on the upside, suggesting strong conviction on the upside. To suggest this momentum, the index first needs to break above the 50 MA at 102.72, which also marks the trend resistance. A break above this level could signal a further upside to 103 before 100 MA at 103.50. Alternatively, support at 102 remains firm, and a breach of this level could set the scene for early February lows of 101. We expect some moderate upside in the near term but for the moving averages to cap any strong momentum.
The pair continued to soften in recent weeks but found support at 102.00 and has traded slightly above it since. The indicators point to a strong buy signal: the %K/%D has converged on the upside and is now rising out of oversold. MACD diff is negative and is about to converge on the upside, suggesting strong conviction on the upside. To suggest this momentum, the index first needs to break above the 50 MA at 102.72, which also marks the trend resistance. A break above this level could signal a further upside to 103 before 100 MA at 103.50. Alternatively, support at 102 remains firm, and a breach of this level could set the scene for early February lows of 101. We expect some moderate upside in the near term but for the moving averages to cap any strong momentum.