Bluffers Always Raise – to call or to fold

This post is an update on our previous one where we hypothesized that Bank of Canada’s (BOC) first rate hike was a mistake and that if crude oil prices continue to fall then the BOC would have to retrace its steps. Since then, we have had another BOC meeting and to our surprise they hiked again. Judging by the market’s reaction, this came as a huge surprise and the Canadian dollar (CAD) rallied close to 200 points against almost every currency. We remain short CAD but we are getting cautious about our presumed catalyst.

Indicators we watch are painting an oversold crude oil market but price action, so far, is muted. Nonetheless, we remain cautious on our bearish outlook for crude oil. We will watch the tape and let prices dictate our conviction. If crude oil prices make a sustained break above current levels around $50 we will lose conviction on our short bias until prices get back above $61. In that event, we will look to exit our short CAD trades with the intention of re-entering when WTI crude oil prices get to $61/barrel.

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Calling Poloz’s Bluff – Short Canadian Dollar

Back in Jan-2015, Gov. Stephen Poloz outlined the bank’s rationale for a rate cut and explained that the bank had relied on a framework in which their base case expectation for crude oil prices was that it would remain around $60 for the next two years, i.e. 2015-2017, and considering this base case that it was prudent to provide some support to the economy in the form of a rate cut to compensate for lower future oil revenues. As we all know, the reality for crude oil turned out to be quite different.

At the most recent monetary policy meeting, the BOC hiked its policy interest rate by 25 bp; what makes it strange is that the year-over-year rate of growth of Canadian core CPI is the lowest it has been going as far back as the 80s!

Crude oil’s price stabilization since early 2016 has led to a substantial unwinding of the CAD shorts, which has further fuelled strong rallies in all CAD pairs. In our view, this CAD rally is about to lose its steam; we have initiated short positions in CAD against the USD, the EUR, and the GBP. The main risk to our trades is that crude oil prices firm from here. While we think the chances of this are low, we will closely watch the crude oil market for signs of strength and continue to evolve our thinking should it be necessary.

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