Canada’s budget for May shows a deficit of C$0.23 billion, compared to a surplus of C$1.17 billion in May 2024. So far this year, Canada’s budget deficit stands at C$6.5 billion. This is much better than the C$43.15 billion deficit reported in the same period last year.

Fiscal Improvement

Recent government financial data presents mixed signals, but the overall trend is positive. Even though May’s budget shows a small C$0.23 billion deficit, the year-to-date deficit has significantly decreased from over C$43 billion to C$6.5 billion. This remarkable improvement in the country’s financial situation is what traders should focus on. This healthier fiscal status supports the Canadian dollar, even as the central bank begins to lower interest rates. We see this as a great chance to sell out-of-the-money USD/CAD call options, which can yield profits if the Canadian dollar remains stable or strengthens. Historically, investors prefer currencies backed by improving government finances. The smaller deficit also affects interest rate derivatives. With less government borrowing needed, bond yields may decrease. However, inflation rose to 2.9% in May, making it difficult for the Bank of Canada. Governor Tiff Macklem may proceed with caution, making heavy bets on more significant rate cuts risky for now.

Market Implications

Due to this uncertainty, we think the implied volatility in currency options is too low. The market isn’t fully accounting for possible surprises from the upcoming inflation report or the central bank’s policy meeting on July 24th. Traders might want to use long straddles on the currency to prepare for a significant price move in either direction. On the equity side, this news is a mild positive for the TSX Composite Index. The improved fiscal outlook supports economic stability, but a modest Q1 GDP growth of 1.7% indicates that the economy isn’t ready to take off yet. We recommend avoiding speculative call buying and instead look at selling puts on solid Canadian banks and energy companies, which benefit from a stable domestic environment. Create your live VT Markets account and start trading now.

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