TD Securities said the Bank of Canada adopted a more hawkish tone at its latest decision, putting greater weight on upside inflation risks while core inflation remains subdued. The economists expect the Overnight Rate to stay at 2.25% through 2026, before moving back to an assumed neutral rate of 2.75% in 2027 via two 25 bp increases, pencilled in for January and March.
Oil prices have largely normalised after rising above $100bbl following the US-Iran conflict, which the note framed as an added shock to the inflation outlook. Headline CPI is described as sitting near the top of the Bank’s 1–3% target band. The report also referenced an escalation in trade tensions through Section 338 tariffs introduced on 22 August, but it said these measures would not, on current assumptions, prevent rate rises in Q1 2027 if there is no further escalation.
Derivative Strategy Amid Bank of Canada’s Hawkish Pause
With the Bank of Canada adopting a hawkish tone, we believe derivative traders should prepare for a prolonged pause at 2.25% through the rest of 2026. Since the central bank is emphasizing upside inflation risks while core inflation remains low, betting on near-term rate cuts is highly risky. We suggest utilizing Canadian Overnight Repo Rate Average (CORRA) futures to position for flat policy rates over the next three months.
Positioning for 2027 Rate Hikes and Inflation-Related Trade Ideas
Looking ahead, the market appears to be underpricing the projected 25-basis-point hikes scheduled for January and March of 2027. We recommend entering pay-fixed overnight index swaps (OIS) to benefit from the anticipated climb toward a 2.75% neutral rate. Historical data shows that front-end yields typically surge rapidly once the market fully aligns with the central bank’s hawkish timeline.
Headline inflation is currently hovering near the top of the 1% to 3% target range, driven by the recent spike in oil prices over $100 per barrel and the Section 338 tariffs enacted on August 22. Despite this pressure, the central bank’s patient stance suggests that short-term interest rate volatility is currently overstated. We advise selling short-dated CAD swaptions to capture premium as the market realizes the policy rate is firmly on hold.
