The lack of aggressive follow-through within the FX options market is noteworthy. This sluggish activity is despite the speed of the move lower in the CAD. Our options desk has seen little willingness to pay-up for aggressive USDCAD topside at these new levels in spot (ref: 1.0810). We suspect that both FX and rates markets are seeking some clarity and direction from one another at this stage. However, neither market appears willing to take the next big step yet. This has probably kept activity within the FX options market rather limited. One specific reason for the lack of follow-through in FX options is probably that participants are already ‘bulled-up’ at the front-end of the Canadian sovereign curve. The tendency to receive in the March-October sector of the OIS curve also suggests that these markets are already leaning in the direction of a BoC rate cut. Two factors are probably halting a move in the 2-yr sectors to below 1.0%. The first is that chances of BoC rate cuts should decline somewhat as the US economy gains momentum. The second is that the advent of the Fed taper by itself reduces the need for the BoC to resort to exigent measures, such as cutting rates.
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BMO