Pound Leaps Against Wounded Canadian Dollar After GDP Shock - More Gains Forecast"

The market’s large net-long position in the Canadian Dollar, combined a step-change at the BoC, is a perfect recipe for a steep correction according to strategists. 

Traders should bet on a rise in the Pound-to-Canadian-Dollar rate, according to one strategist, who says the pair could rise given unrealistic expectations of the Bank of Canada and the prospect of the Bank of England signalling a hawkish shift in its own policy statement Thursday.

Buying the GBP/CAD pair around market levels and targeting a move up toward 1.72 is a good way for traders to play diverging expectations for central bank policies on either side of the Atlantic.

“Given the asymmetric risks around the CAD and our hawkish view of the BOE, we think there is value in expressing GBPCAD topside, eying 1.72 with supports near 1.68,” says Mazen Issa, a strategist at TD Securities.

Issa’s recommendation came ahead of a turn for the worse in Canadian macroeconomic data and mid-way through a reappraisal by the market of the likely pace at which the Bank of Canada will hike rates over the coming quarters.

The Dollar wilted Tuesday after Statistics Canada data showed the economy contracting by -0.1% during August, after grinding to a halt in July, when economists had forecast growth of 0.1%.

The Pound-to-Canadian-Dollar rate was quoted 0.83% higher at 1.7086 during noon trading.

GBP/CAD rate shown over 1 hour intervals.

“All told, a weak result has us on track to see the deceleration in growth in Q3 that we were expecting, to less than half the pace seen in Q2,,” says Nick Exarhos, an economist at CIBC Capital Markets.

Markets had been betting heavily on a December rate hike from the Bank of Canada, more or less ever since the central bank last raised the cash rate back in September.

“Against this backdrop, we think risks around CAD are asymmetric and more vulnerable to data disappointments than an upside surprise,” says TD’s Issa.

Then there is market positioning. Traders have built a near-record net-long Canadian Dollar position during recent months in response to an economy that strengthened in the first half and a central bank that appeared to have an itchy trigger finger.

“IMM data points to an overhang of CAD longs while the premium for 3m riskies continues to move higher. We think this leaves USDCAD dips shallow and prone to a position squeeze higher,” says Issa.

Canadian rate setters used last week’s policy statement to signal a greater willingness to ‘wait and see’ before moving rates again. Their newfound patience comes after the Bank of Canada’s pushed through two back-to-back interest rate hikes between July and September.

“You have to be extremely creative to generate a scenario in which the Bank moves in December. As that probability fades to zero in the coming weeks, the Canadian dollar will feel the pain,” says Benjamin Tal, a strategist at CIBC.

Governor Poloz said last week that the BoC is waiting to observe the effect that higher rates have on the economy, particularly households, as well as on progress toward the central bank’s inflation target.

GBP/CAD rate shown over weekly intervals.

“For some odd reason the market is still attaching a 28% probability to a December move. That’s 28% too high,” says Tal.

Despite interest rate market prices still pricing some chance of a rate hike in December, most economists and strategists have begun to move their predictions for another BoC hike out into 2018. But at least one voice predicts more than a few months gap before the next hike.

“After a strong growth performance so far this year, Canada's economy looks on the verge of a downturn as the housing boom turns to bust,” wrote Paul Ashworth, chief North American economist at Capital Economics, in a September note. “We expect GDP growth to slow sharply next year, prompting the Bank of Canada to reverse its tightening cycle.”

Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.