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Macro and Vol Commentary

The Canadian dollar has been softening for most of June, finding a support level at 1.28. More recently, the currency and oil joined other risk assets in selling off, as producers finalised the agreement to increase production starting August and to extend the deal until December 2022. What is next for USDCAD?

The Economy

  • COVID-19 third, and the strongest wave of infections, has come down drastically since the peak in April, driven by the uptake of vaccines
    • The number of vaccinated continues to grow, albeit at a slower pace, since the beginning of July
    • This could be attributed to a majority of the population, 70%, already being given the first dose
    • We have seen a marginal uptick in cases in recent days up to 1,074 per day; however, deaths have been declining since late April, highlighting vaccines’ efficacy against the virus
  • Retail sales jumped by 4.4% in June as the economy began lifting lockdown restrictions, which stunted shopping earlier this year
  • Most of the provincial reopenings took place in June, and therefore we expect stronger economic figures in the next couple of months as we have seen in other recovering economies
    • Indeed, the economy is now seen in full-swing recovery, catching up to the rest of the developed nations
    • Bloomberg expects the economy to grow at 9.1% in Q3 2021
  • Likewise, employment numbers rose by 230.7k in June, the highest since March
    • Unemployment declined to 7.8% from 8.2% in the previous month
  • A gauge of business sentiment rose to record levels of 4.2 in Q2 2021 as an accelerated vaccine rollout bolstered confidence in the recovery
    • Senior managers reported strong sale outlooks, elevated investment intentions, and record hiring plans
    • However, at the same time, capacity constraints are at all-time highs and rising expectations of higher inflation and wages
  • GDP fell by 0.3% m/m in April, greater than expected, proving the nation's resilience to lockdown measures introduced for most of Q2
  • Inflation reached 3.6% y/y in May, the greatest jump since 2011, given May 2020 low base
    • For June, the consumer inflation is expected to grow yet soften month-on-month, at 0.4% m/m
    • The CPI consumption basket weights have been updated, and so June’s figure might be different to what is expected.

The Central Bank Rate Decision

  • The Bank of Canada took another step to ease the emergency level of support by tapering its bond purchases in a sign of optimism amid the speed of economic recovery
    • The purchases would be reduced by one-third to $1.6bn
    • The benchmark rate remained unchanged at 0.25%
    • Further hikes are unlikely until the second half of 2022, but then, multiple increases would be needed to cool the economy
  • This marks the third time the officials have downsized the asset purchase programme, reinforcing the expectations that Canada might be one of the first developed economies to hike rates
  • The investors are now pricing in a hike over the next 12 months, whereas the US expects only two over the next two years, with no immediate hike in the meantime
  • The bank reiterated that it will not raise its rate until the recovery is complete and inflation is running sustainably at 2%
    • Bank of Canada expects economic output to reach 6% in 2021 and inflation to be at or above 3% on the back of hopes of pent up demand aiding recovery
    • Indeed, it is estimated the Canadian households have $178bn in excess savings accumulated during the pandemic
    • A separate consumer survey found that spending expectations are near a record, reflecting Canadians' desire to unleash pent-up savings once restrictions ease
    • Therefore, 3% inflation is likely to remain for much of the rest of the year

The Canadian dollar has partially recovered from the correction seen in June; however, in the near term, it should be tied to movements in risk sentiment. The delta variant spread has been swaying the markets, and if it proves to be enough to offset the growing vaccination numbers, we would see risks spike and cap the CAD growth. Likewise, while the oil market remains tight, growing forecast output from the OPEC+ should cap any further price gains.

Volatility Commentary

Recently we’ve seen FX Macro Vols (implied and realised) as the market still harbours concerns over the Covid Delta variant, in addition, the recent OPEC clashes also drove up volatility in USDCAD with realised volatility coming in higher than implied (though for the moment OPEC has come to an agreement on oil output). We’ve recently seen BoC hold rates alongside a reduction in their bond purchasing programme and a lot of attention will be paid to this week’s FOMC on the USD side with the entire market eyeing what/if any action the Fed will take on US inflation. With concerns still hanging around in the market over the Covid Delta variant and uncertainty around USD/Fed policy, we favour slight long gamma/vega positions on this pair.

USDCAD 1-month Implied and Realised Volatility

USDCAD Trade Idea

  • Buy 1-month USDCAD Straddle for circa 7.00 vols
  • Delta hedge long delta/gamma position
  • Priced in 10m USD Notional per leg (20m USD Notional total) gives circa 23k USD vega
  • Trade only suitable for investors with the capability to manage and delta hedge short gamma position

Positioning Charts

USDBRL NDO Positioning Data 13/07/2021 - 20/07/2021

Puts have once again dictated the market trading in the week to July 27th, suggesting further downside pressures in the near term. However, the conviction has lessened, driven by falling notional size for puts and growing for calls. There is a strip of puts for expiry in the first week of August which range from 4.90 to 5.30, with sizeable notional on the lower end of the range. This range narrowed in the week ending July 27th, suggesting we could see a change in trend in the near term.

USDBRL NDO Positioning Data 20/07/2021 - 27/07/2021

USDCNY Vanilla Positioning Data 13/07/2021 - 20/07/2021

Options volume increased marginally in the week ending July 27th, the range widened out a bit more towards higher levels. The range in Chart 1 is around 6.25 to 6.80, whereas in Chart 2, it is 6.25 to 7.00, mostly driven by a higher number of calls. This suggests an appetite for higher prices. There are some large call options due to expire in April 2022.

USDCNY Vanilla Positioning Data 20/07/2021 - 27/07/2021

USDCAD Vanilla Positioning Data 27/05/2021 - 27/06/2021

Volumes increased marginally in the month ending July 27th, and the range shifted to higher price levels. The market found support at 1.28 and has been trading lower in recent sessions. However, calls notional have increased in size and there is a large call option at around 1.40, suggesting we could we prices consolidate in the near term. Most of the expirations are focused on the near term; there is little upside cover above 1.35 in the near term, but the majority of options executed are between 1.2-1.3.

USDCAD Vanilla Positioning Data 27/06/2021 – 27/07/2021

Charts and Tables

FX Expiries

Volatility Grid

Historical Spot FX Volatility (30D Rolling)

FX Matrix (today)

Weekly Change

Key Events & Releases

Technical Charts

JP Morgan Global FX Volatility Index 

The index held above the 200 MA this week, keeping momentum on the front foot. However, the stochastics are falling out of the overbought, and the MACD is positive and converging on the downside. The index has remained supported despite the selloff in the indicators, holding up well above the moving averages. Recent rallies have been sold off, and to confirm the outlook of lower prices, the index needs to break below the moving averages and then support at 6.70. On the upside, if the index can breach 6.90 and then target 7.00, we could see a change of momentum to the upside, confirming a continuation of ascending triangle. We expect prices to soften in the near term.

Dollar Index

The dollar index has contracted sharply in the last couple of sessions, breaching the 200 MA level of 92.20. The stochastics are falling further into the oversold, and MACD diff suggests lower prices; we could see breakthrough support at the 92.00 to 61.8% fib level at 91.72. The three black crows formation alongside the breach of long term support points to strong bearish momentum in the near term. On the upside, if support at 92.00 holds firm, this could trigger gains back above 200 MA towards the 100 MA at 92.607. In order to regain upside conviction, the index needs to gain a footing above the 50 MA at 92.73, a robust resistance level.

USDCAD

The pair has weakened in recent sessions, falling below the 1.25 support level to close at 1.266. The stochastics are seen falling, as %K/%D crossed into in the oversold, suggesting we could see further downside momentum. Likewise, the MACD is negative and diverging on the downside, supporting the outlook for downward momentum. On the upside, the break above yesterday’s highs of 1.260 could set the prices to test the 50 MA at 1.2602. Conversely, to confirm the outlook for lower prices, the pair needs to take out the key support of 200 MA at 1.2455, which would signal a strong bearish momentum. A breach of this level could trigger a test at 1.24 and then 1.23, the levels last seen at the beginning of the month.

Contents

Disclaimer

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COVID cases are rising across the globe as the delta variant spreads, this is causing some nervousness in financial markets, especially with the higher inflation rhetoric. Commodity prices have fallen since the Fed changed their tune inflation, the dollar has stabilised which has also been a headwind to prices. The summer months are traditionally quieter for metals demand which could prompt metals to consolidate. If the delta variant continues to spread, we may see higher levels of stimulus for longer. As things stand stimulus levels are set to be tapered and this could be brought forward if inflation remains high. We expect markets to remain volatile but on lower volume through the summer months.