Canada’s upcoming budget will likely emphasize both spending cuts and investments. There are rumors of a possible 15% reduction across various department budgets, but funding for provinces related to education and individual transfers should stay the same. Many are worried about the government’s current spending levels, which are seen as unsustainable. Recently, there was a discussion between Carney and Trump, but no additional details were shared. These changes might boost the bond market, though they could hinder economic growth. The USD/CAD exchange rate has increased by 9 pips, reaching 1.3789. The market is responding to concerns about slow growth, pushing the USD/CAD rate higher, as austerity measures typically raise worries about short-term economic health. We view this as an immediate reaction that overlooks the positive effects on Canada’s fiscal health and the specifics of proposed investments. Traders should be careful not to chase this initial movement, as the story could quickly change. This plan for spending cuts gives the Bank of Canada more flexibility, possibly allowing for interest rate holds or even cuts sooner if the economy weakens. The futures market is beginning to reflect this, with the chances of a rate cut in the first half of 2026 increasing slightly this morning. We should consider options on the Bank’s overnight rate to prepare for a possible shift toward lower rates. For the bond market, this signals positive trends. With Canada’s federal debt-to-GDP ratio recently at 48%, moving toward austerity may lower future government bond supply and show fiscal responsibility. We expect yields on the 10-year Canada bond, currently at 3.4%, to drop toward 3.0% as the budget details are finalized. The outlook for Canadian stocks is more uncertain, which likely means increased volatility. Implied volatility on TSX options has already risen to a three-month high of 18%, indicating that traders are preparing for larger price fluctuations. We see value in buying put options on the broader index to protect against a slowdown in growth while also looking for call options in sectors like infrastructure and green energy that might benefit from the budget’s investment side. The conversation with the Trump administration adds another level of risk we cannot ignore. While described as ‘good’, any shifts in trade policy could easily overshadow domestic fiscal news, similar to the trade disputes of 2018. Holding some longer-dated call options on USD/CAD can provide a cost-effective hedge against any unexpected political tensions from the U.S.

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