USD/CAD: Bank of Canada decision not a game changer; position for a move lower

The CAD has been notable underperformer this week, as a more dovish tone in the statement pushed market expectations about the timing of first rate hike further into the future. Indeed, our economists now expect the BoC to start its tightening cycle in Q1 2014 with a 25bp hike, rather than in Q2 2013. However, they maintain a small hawkish bias and continue to suggest that the next move is more likely to be a hike than a cut – a point reinforced by Governor Carney’s post-announcement commentary, in which he mentioned that the timing of possible rate moves has changed, but the direction is clear.

Post-announcement price actions suggest that the market’s re-pricing of the BoC rate profile is done and that the BoC is unlikely to ease unless under extreme circumstances, such as either a significant negative growth shock to the US or a sudden collapse of the Canadian housing market (neither of which is our baseline case). And we expect USD/CAD to move back onto a gradual downward trend, helped by robust oil prices (Figure 2) and improving market sentiment (Figure 3), as well as demand for high quality, fixed income assets. Valuation is likely to slow the pace of CAD appreciation, but the degree of overvaluation is expected to remain modest from a historical perspective, according to our BEER model (Figure 4), and we maintain our USD/CAD 12m forecast of 0.95.

Political uncertainty in the US over sequester is likely the biggest near-term downside risk to our moderately constructive view on the CAD, given the Canadian economy’s strong trading ties with the US. But we think that market conditions would remain constructive on the assumption that policy makers will be able to come up with a compromise, supporting a modest and gradual appreciation of the CAD in the next one month.

In order to express our view, we recommend buying a 1m USD/CAD 1×1 0.98-1.00 put spread for 0.45% (spot ref 1.003). The trade would benefit from a slow move lower in USD/CAD over the next month and provides a 2.1:1 payout if USD/CAD gets to our 1m forecast of 0.98.

Figure 1: New set of forecasts suggests that rates will stay at 1% for longer

 

 

 

 

 

 

 

 

Source: Barclays Research

Figure 2: WTI likely CAD supportive in 2013

 

 

 

 

 

 

 

 

Source: Barclays Research, Bloomberg

Figure 3: Improved market sentiment also CAD positive

 

 

 

 

 

 

 

 

Source: Bloomberg

Figure 4: CAD overvaluation expected to remain modest from a historical perspective

 

 

 

 

 

 

 

 

Source: Barclays Research