"In terms of alpha-generation – we like being short GBP/CAD from here" - CIBC.

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The British Pound might be the best performer of the major currencies for March, and indeed over 2023 as a whole, but it is now forecasted to face a setback against the Canadian Dollar.

This is according to a new update from the foreign exchange research and strategy team at one of Canada's largest banks.

"In terms of alpha-generation – we like being short GBP/CAD from here," says Bipan Rai, Global Head of Foreign Exchange Strategy at CIBC Capital Markets.

Rai and his colleagues are also looking for USD/CAD to retreat over the coming quarter as the Canadian Dollar is poised to break a recent spell of underperformance.

The calls come at a time of ongoing recovery in the Sterling complex linked to calmer domestic politics, a spate of better-than-expected economic data outturns and a UK banking sector that has proven unfazed by recent turmoil in the U.S., Switzerland and Eurozone.

The Pound to Canadian Dollar exchange rate (GBP/CAD) advanced 2.16% in March, its strongest monthly gain since November 2022's 3.66% rally.

In fact, the Pound has now risen against its Canadian counterpart for seven months in succession with a new high March high at 1.6866 representing a 20% advance from the multi-year low at 1.4063 reached in September 2022, the month that saw UK markets suffer significant outflows linked to the mini-budget debacle of former Prime Minister Liz Truss.

The Canadian Dollar is a mid-table performer for the past month and for 2023 as a whole, but Rai reckons selling the currency doesn't make sense at this juncture.

He takes particular umbrage with the revelation that last month hedge funds and money managers flipped to net short CAD positions in the futures market (as per CME position data).

"When you consider that asset managers have been heavily short CAD futures for some time, the swing in leveraged money positioning to a bearish CAD stance is notable. The question is why?" he opines. "What is it about the CAD right now that makes it a compelling currency to short in this environment?"

His research reveals an investor would be better placed taking the other side of the trade.

He finds the CAD's recent selloff alongside the U.S. Dollar appears to be in part linked to U.S. baking stresses, but this is unjustified as the Canadian banking sector is an entirely different proposition.

"In Canada, there’s little in the way of a corollary. The banking system isn’t nearly as fragmented, and banks don’t see the same degree of deposit volatility. In fact, unlike US banks, CAD banks have seen considerable deposit growth over the past few years," says Rai.

"Position proxies tell us that hedge funds and asset managers are now heavily short the CAD. In fact, the standardized score of extant net shorts is -2.48 (using a three year window). Going back in time, strategies that go long CAD when the z-score crosses -2.0 would have generated decent returns using a 1-month holding period - CIBC.

The Bank of Canada's recent decision to pause its rate hiking cycle - ahead of its developed market peers - is cited as another reason investors have opted to sell the Canadian currency.

But Rai reckons the group of central banks entering a 'conditional pause' is expected to grow in the next few months.

"In fact, we have the Bank of England now likely at that stage, while the Fed, and RBA might not be that far behind," says Rai.

This leads him to eye the GBP/CAD exchange rate as an ideal candidate for a pullback as recent themes fade.

"In terms of alpha-generation – we like being short GBP/CAD from here as we envisage a move to the 1.61 area over the coming period," says Rai.

CIBC Capital calculates that GBP/CAD is now some 0.50% overvalued against their fair value modelling, which would have the pair at 1.6663, which is below the current level in spot at 1.6750.

"The trade setup looks relatively appealing as price action for the cross appears to be rolling over just below a key resistance area at 1.6840/50," says Rai.

CIBC Capital Markets targets a return in the pair to 1.61 in a new trade opened March 30.

But the Canadian Dollar is also tipped to outperform its southern neighbour with CIBC looking for a return to 1.30 in the U.S. Dollar-Canadian Dollar exchange rate over the next three months.

"The USD should continue to come under pressure. The Fed’s QT program is less tenable in an environment where the Fed is pumping out liquidity via lending to banks. Additionally, the proximity to the debt ceiling cliff will come into sharper relief into the early summer," says Rai.