Loonie Hedges Signal Bulls

Bond funds renew hedges on Canadian dollar, expecting currency to strengthen after its worst start to a year since 1972.

After the worst annual start in more than four decades for Canada’s dollar, recent moves by the nation’s money managers suggest it may be about to turn around.

TD Asset Management, which oversees Canada’s second-biggest bond fund; Sprott Asset Management LP; and Franklin Bissett Investment Management say they’re putting on hedges that would protect against the currency strengthening. That marks a switch from earlier in the year, when they unwound, or let lapse, positions in futures contracts or swap agreements as the local dollar plummeted versus its U.S. counterpart.

Investors are not ready to bet on further depreciation after the Bank of Canada noted last week that inflation and economic growth have been stronger than forecast as policy makers kept interest rates at 1 percent. Year-end forecasts have stabilized, after jumping to C$1.12 per U.S. dollar in the middle of February, from C$1.08 at the end of last year.

“We had no hedges on for a considerable period of time, and we have recently re-established our Canadian dollar hedges,” Robert Pemberton, head of fixed income at TD Asset Management, a unit of Toronto-Dominion Bank, said by phone. “The Bank of Canada is likely to maintain a very accommodative stance over a considerable period of time, and I don’t foresee a change in rates in the near future.”

At the same time, speculators and hedge funds have reduced wagers for further declines in the currency from the third-biggest short position on record.

The most recent data from the Washington-based Commodity Futures Trading Commission (CFTC) show bets for the currency to decline outnumbered those for it to rise by 61,096 contracts on March 4. That net-short position is down from 70,327 on Jan. 24, which was the third biggest negative imbalance on record.

“Positioning is still pretty underweight Canadian dollar, so in the near term you should probably see range-bound markets in the currency,” Michael Craig, a fixed-income money manager at Sprott, said in a Feb. 28 phone interview. “Just because of positioning and expectations getting ahead of it, I think you’ve got to dial back your short Canadian dollar positions.”

Craig said he reintroduced hedges protecting his U.S. dollar holdings from Canadian dollar strength at the end of last month, though he reduced them a little after last week’s data showing Canada lost jobs in February.


Reducing Profits

Foreign-exchange hedges are meant to prevent unfavorable currency movements from eating into profits on investments such as fixed-income securities. A Canadian investor hedges U.S. holdings by initiating bets that pay off when the local dollar rises against its U.S. peer, offsetting the corresponding decline in the greenback assets’ value when they’re converted into the Canadian currency.

The downside of these hedges is that they also cancel out the benefits of a rising U.S. dollar, which inflates U.S. profits when they’re brought back to Canada.

Investors such as Pemberton did without this protection at the beginning of the year in a bet that Canada’s dollar would decline. In January, the currency fell 4.5 percent in its worst start to a year since at least 1972.

Triggering January’s decline were bets the central bank would lower interest rates after it forecast inflation would stay near the bottom of its 1 percent-to-3 percent target band and flagged the strong currency as a headwind to exports.

The Canadian dollar has stabilized since, as the Bank of Canada’s latest statement dropped the mention of a strong currency and noted that the latest readings on economic growth and inflation were stronger than expected. Worse-than-forecast jobs numbers last week kicked off two straight days of declines.

The loonie, as the currency is known for the image of the aquatic bird on the C$1 coin, fell to C$1.1224 per U.S. dollar on Jan. 31, the weakest level since July 2009, and was at C$1.1129 as of 9:30 a.m. in London. One loonie buys 89.86 U.S. cents. The currency is the worst performer among 16 major peers against the U.S. dollar this year, dropping 4.6 percent.

It’s forecast to weaken to C$1.12 by July and remain at that level through the second half of the year, according to the median estimates in Bloomberg surveys of economists.

The loonie is at about fair value at these levels, though it may strengthen as economic growth causes speculators to abandon bearish bets, Pemberton said Feb. 28.


‘Escape Velocity’

Wagers for the Canadian dollar to decline were, in part, based on accelerating U.S. growth, which has been mixed. Since the beginning of the year, the world’s largest economy has seen data on gross domestic product, manufacturing activity, and retail sales all come in below analysts’ expectations, though the latest jobs report beat forecasts.

“The current exuberance from the U.S. dollar strength may be a little overdone,” Darcy Briggs, a fixed-income manager who helps invest C$4 billion at Franklin Bissett, said by phone Feb. 28 from Calgary. The theory that “the U.S. economy has achieved escape velocity is proving a little more elusive than the consensus and a lot of market participants thought at the beginning of the year.”

That means the Canadian currency is as likely to rise from current levels as it is to fall, which has led Franklin Bissett to re-establish some of its hedges on its U.S. dollar investments, Briggs said.

“Our base-case scenario is the macro data out of Canada is not as dire as the foreign-exchange market had thought,” he said. “Foreign-exchange markets haven’t adjusted to that.”

Page 1 of 2

Copyright 2017 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.


Advertisement. Closing in 15 seconds.