USD/CAD pushed higher on Thursday to its strongest level since mid-July and was trading near 1.4113, up almost 2% on the month, after logging just one daily fall in the past 12 sessions as the Federal Reserve and Bank of Canada outlooks diverged. Canadian Retail Sales failed to shore up the CAD: headline sales fell 0.7% month-on-month in July versus a 0.8% drop expected, while sales excluding autos also declined 0.7%.
The move has tracked a widening two-year yield spread, with the US Treasury yield around 4.89% after a 4.94% peak—its highest since 2004—against Canada’s two-year near 3.40%, a gap of almost 150 basis points. Benchmark yields have risen as markets price another Fed hike after last week’s 25 bps increase took the federal funds rate to 3.75%–4.00%, lifting the US Dollar Index (DXY) to about 101.37, its highest since July 29. US Initial Jobless Claims edged down to 197K from a revised 198K, below 201K expected, and the S&P Global Composite PMI rose to 58.4 in September from 56.0. The CME FedWatch Tool shows a roughly 65% chance of an October hike versus 55% a week earlier, while the BoC has held 2.25% for seven meetings; inflation ex-gasoline was 2.2% in July with core near 2%, as WTI traded around $95, up nearly 11% this month.
Derivative Trading Strategies for USD/CAD Momentum
We recommend that derivative traders position for continued upward momentum in the USD/CAD pair by utilizing long call options or bull call spreads. With the pair trading around 1.4113 and marking its highest level since mid-July, the technical breakout suggests there is room to run toward the 1.4250 resistance level. This bullish stance is heavily backed by the diverging paths of the Federal Reserve and the Bank of Canada.
The massive 150-basis-point yield gap between the US and Canadian two-year bonds is the primary engine driving this rally. Historically, when the yield spread between these two nations widens past 100 basis points in favor of the US, the greenback experiences prolonged periods of dominance. We believe traders should exploit this yield disparity by selling short-term CAD futures and buying USD counterparts to capture the carry.
Yield Spreads, Oil Disconnect, and Policy Divergence
Interestingly, the traditional positive correlation between the Canadian Dollar and crude oil has completely broken down. Even though West Texas Intermediate crude has surged 11% this month to around $95 a barrel, the CAD remains weak due to the Bank of Canada’s steady policy rate of 2.25%. We advise against using oil strength as a reason to buy CAD right now, as monetary policy divergence is clearly overriding commodity support.
With the CME FedWatch Tool pricing in a 65% chance of another Fed rate hike in October, the US Dollar Index is poised to test new highs past its current 101.37 level. Meanwhile, weak Canadian retail sales, which fell 0.7% in July, give the Bank of Canada very little economic justification to tighten policy. We suggest buying short-dated USD/CAD call options to capture the anticipated volatility leading up to the upcoming central bank meetings in the next few weeks.
