The Canadian Dollar is holding near one-month highs against the US Dollar, with USD/CAD consolidating around 1.4000 after a fall of about 1.25% over the past two weeks. Attention is turning to Canada’s CPI release, where June inflation is expected to slow to 2.9% year on year from 3.2% in May, while the monthly reading is seen contracting 0.2% after a 1% rise previously. Softer CPI would ease pressure on the Bank of Canada to tighten policy, although the figures predate a 20% rally in oil prices in July that could temper the market response.
Oil’s advance has supported the Loonie, as crude is Canada’s main export and prices have climbed more than 20% since the US and Iran resumed hostilities and Tehran again blocked the Strait of Hormuz. Meanwhile, the US Dollar weakened after softer US consumer and producer prices. Market pricing for a July Federal Reserve rate rise fell to 12% from nearly 42% a week earlier, and September hike odds eased to 57% from about 75%, according to the CME FedWatch Tool.
Opportunities in USD/CAD and Oil Price Derivatives
We see a prime opportunity for derivative traders to exploit the current consolidation of the USD/CAD pair near the crucial 1.4000 level. Given that the Canadian Dollar has appreciated by 1.25% over the past fortnight, we recommend buying short-term USD/CAD straddles to capitalize on the upcoming CPI volatility. This strategy allows us to benefit from sharp movements in either direction, especially as June inflation is projected to drop to 2.9% from 3.2%.
The massive 20% surge in oil prices, driven by the blockade of the Strait of Hormuz, provides a strong safety net for the Canadian economy. Historically, a sustained 10% increase in crude oil prices correlates with a 1.5% appreciation in the Canadian Dollar over the following weeks. To leverage this, we suggest derivative traders maintain long positions in crude oil futures or buy out-of-the-money call options.
Interest Rate Divergence and Monetary Policy Trades
With the CME FedWatch Tool showing a dramatic fall in July US rate hike expectations to just 12%, we see a widening divergence between the Federal Reserve and the Bank of Canada. We advise trading short-term interest rate futures to position for a pause in US rate hikes. Easing Canadian CPI also means we can look at overnight index swaps pricing in a more dovish stance from the Bank of Canada in the coming weeks.
