The Canadian Dollar (CAD) had a strong week as the US Dollar (USD) fell by 1.6% by Friday. This made the CAD one of the stronger major currencies of the week. Interestingly, there is a rare negative correlation between the CAD and US stocks, currently at -36% over the past month. Normally, the CAD would move in sync with the stock market, providing some stability against US market fluctuations.

Bank Of Canada Commentary

Bank of Canada Governor Macklem mentioned that core inflation is becoming more volatile. He indicated that several factors will influence the next interest rate decision, hinting at possible changes in the market. The USD’s drop below the 1.3745/50 level could lead to further gains for the CAD. The USD lacks strong support until it reaches the 1.34/1.35 range, which may lead to a full retracement to 1.3420. This recent shift indicates a break from usual trends. The CAD is rising while US stocks decline, reversing the typical relationship. Usually, when stocks rise, the Loonie also appreciates. Instead, we are witnessing the opposite, as shown by the -36% correlation. This suggests the CAD is now driven by different factors, possibly related to monetary expectations or demand for Canadian assets. When the usual indicators are quiet, we look to other signs. Macklem’s comments earlier in the week provided more context. While he did not give clear guidance, his mention of “increased volatility” in core inflation sounded more like a warning. When a central bank recognizes conflicting inflation pressures and states that “multiple factors” will affect its next decision, it suggests a preference for flexibility rather than strict rules. Fluctuations in inflation data might lead to unexpected changes, emphasizing the importance of upcoming data such as retail sales and labor market developments.

Volatility Pricing And Risk Appetite

Looking at price action, the USD’s decline below the 1.3745/50 level changes short-term expectations significantly. Without that support, we may now enter a wide, less competitive range in the low- to mid-1.34s. The last time prices lingered in that area was in January, where they quickly moved through. This indicates that liquidity may become uneven, potentially driving momentum in either direction. If momentum traders increase short positions on USD/CAD, reaching 1.3420 is possible, though not certain. Closing older USD positions might enhance this movement. For trading with derivatives, all of this highlights the need to focus on volatility pricing. Premiums for CAD calls may still not accurately reflect the scale and speed of currency changes, given the unusual correlations and potential shifts in local rate expectations. It’s worth considering spreads that lean towards a moderate but directional decline in USD/CAD. However, protective measures should be taken, especially with macroeconomic events like US jobs data and Canadian CPI approaching. Additionally, if risk appetite continues to wane and the CAD keeps strengthening, carry trades based on interest rate differences may not offer their usual protection. The quiet from Canadian policymakers this week could shift to more direct communication if the market anticipates rate cuts or overlooks inflation figures. This isn’t the current expectation, but we shouldn’t assume that past correlations will always hold. Finally, it’s important to recognize that positioning behavior may override technical indicators. Large investors could react more quickly to changes and not wait for traditional confirmations, leading to increased short-term volatility. The market may not fully adapt to these changes, which is something to keep an eye on. Create your live VT Markets account and start trading now.

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