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Macro and Vol Commentary

The Canadian dollar has recovered well since selling off in March, but can the currency continue?

Canadian Data

  • Canada has tightened its grip on the battle with COVID-19 as deaths, and cases fall. However, its recovery is hindered by key trading partners fight with the virus
  • Markit Mfg PMI continues to recover with June’s figure at 47.8, up from 40.6 in May. Output fell by the least since March; manufacturers noted that consumers remained cautious due to uncertain climate
  • Supply chains remain under pressure, with 35% of the Markit survey suggesting supplier performance worsened in June.
    • We expect a modest recovery in July but believe that capacity will run lower for longer and economic progress is capped by key trade partners climate
  • Higher frequency data suggest that economic activity is improving
    • Transport usage -55 the highest it has been since April
    • Restaurant bookings also showed the highest reading since April at -50
  • The unemployment rate has started to fall, to 12.3% in June from 13.7%
    • The net change in employment is positive once again at 952,900 in June
    • The participation rate is improving towards 63.8%
    • The hourly wage rate fell to 6.8% as workers on lower salaries came back to work
  • The business outlook survey indicator declined to the lowest rate since the GFC in Q2 to -7; we expect this level to increase in Q3
  • Uncertainty in consumers will prevail and is expected to provide headwind inflation and retail sales, supply-side restrictions
  • Canadian rig counts have fallen significantly in recent months to low prices, and stand at 26, which is an improvement on the week prior from 18
    • February’s rig count was 257
  • Oil exports by rail plunged to 156,242bl/d, a far cry from February’s exports of 412,000bl/d
  • The reduced demand for oil has heavily impacted Canada, but the cuts from OPEC+ and a slight improvement in the demand has supported prices, and you have seen a response from Canadian rigs
  • Exports should start to improve for the remainder of H2 2020

Bank of Canada & Government

  • We expect the BOC to keep rates low to support the economy
  • The bank are expected to reduce stimulus packages that support market functioning
  • QE is here to stay and the Government Of Canada Bond Purchase Program (GBPP), is set at CAD 5bn/week of bonds
    • The BOCs total assets have increased to 17% of GDP
  • Canadian gov’t has increased its deficit to 13% for this fiscal year
    • Emergency response benefit pays C$2,000/month for those who lost income
    • Emergency wage support was C$847/week per employee
  • We expect the government and BOC balance sheets to rise, but as oil production improves the trade balance

We saw some flows away from CAD last week and the 4 weeks prior for leveraged money, according to Citi velocity. Real money flows for last week also marginally decreased. Canada’s close relationship with the US may have reduced the appeal of CAD in recent weeks, even though economic activity is improving. We expect the BOC to keep policy accommodative which should aid the recovery; however, from the consumer perspective, the chronically uncertain times will reduce their propensity to spend which will provide a headwind to the economy. The recovery should continue in Q3, but the labour is expected to lengthen the recovery; indeed if the oil market remains on the back foot, we expect this to also act as a headwind to the economy, however as economic activity picks up we expect demand for Canadian oil to improve. The US is recording near-record infections, but deaths remain low, uncertainty is still considerably high, but the stock market has started to consolidate, suggesting apprehension in the market.

Volatility Commentary 

Over the last few months, USDCAD implied and realised vol comments had dripped lower, but lately, vol has been realising higher than implied. Given Canada’s large oil exports CAD will be exposed to global economic recovery and a recovery in oil demand. Though we expect to see a recovery, this will not be not straight forward, as evidenced by countries having had to unwind certain unlock measures with local lockdowns which will stagger the path for recovery. We expect to see USDCAD spot over the longer-term move further down gradually as the Global Macroeconomy recovers though expect shorter-term volatility and as such favour slight long vol/gamma positions on this pair right now.

USDCAD Trade Idea

  • Priced in 10m USD notional
  • Buy 6-month KI Put option with strike 1.3400 and KI Barrier 1.3700 for circa 75k USD Premium (For reference vanilla equivalent cost being circa 110k USD premium)
  • Sell 6-month Put option with strike 1.3100 fir circa 49k USD premium
  • Total premium cost circa 26k USD

Charts and Tables

Technical Charts 

JPM Global FX Volatility Index 

The index broke below key support but has held above 7.50. The indicators are positive and the MACD diff is in positive territory but lacks conviction. The market has failed to confirm the strong stochastics by not breaking above key resistance at 7.63. The repeated reaffirmation of resistance and failure to confirm the bullish engulfing candle suggests we could see the index soften towards 7 in the near term. On the upside, the index needs to take out the band of resistance at 7.63 – 7.65 in order to improve upside conviction. The longer term resistance level stands at 8.02. We anticipate prices to remain on trend and soften in the near term after failing to gain conviction on the upside.

USDCAD

The pair has weakened in recent months after USD strength caused a test of appetite above 1.4600. Trend resistance has held strong in recent months prompting tests of support around 1.33, incidentally this level has held firm and a descending triangle has been formed. In rejection of trend resistance has prompted a correction to the downside as stochastics continue to fall. The MACD diff is negative and starting to diverge suggesting lower prices in the near term. The most recent candle is an inverted hammer which does suggest improving buying pressure, to confirm this, futures need to breach trend resistance. However, to confirm the correction on the downside futures need to break below the 200 DMA and then target 1.35.

 

Dollar Index

The dollar index has remained on trend in the last week, as resistance at the 200 DMA and 50 DMA has held firm keeping the index on the back foot. The stochastics are in negative territory but are starting to show signs of bottoming out, a buy signal could trigger a test of resistance at the 50 and 200 DMA. A break of this level could prompt a breakout towards 98. However, selling pressure has been strong and rallies sold into suggesting lack of appetite for higher prices. A break of support at 95.648 would confirm the sell off and could trigger further losses towards 95.

Contents

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