Implied one-month U.S. dollar/Canadian dollar vol retraced in the latter half of last week after seesawing in the middle of the week. Implied one-month vol rose as high as 6.6% just prior to the Bank of Canada announcing a 50 basis point interest rate cut on Tuesday. The cut was seen as positive for the Canadian dollar--immediately after the cut, the Canadian dollar rose to about CAD1.5375, said Ashif Jiwani, executive director, head fx options trader at CIBC World Markets in Toronto.
Players sold short-dated vol as uncertainty was removed from the market, causing one-week implied vol to fall to 6.25% from 6.75%. Soon thereafter, the Canadian dollar fell to about CAD1.55, as there were customer orders for U.S. dollars. "The market began wondering if there was something it didn't know," said Jiwani. As the Canadian dollar fell, vol increased again. Players then covered short vol positions by buying interweek vol, which lifted from about 7% to about 9%. By Thursday, the market had settled down, to about the high 7% range for interweek vol.
Volatility in the currency pair began trending upward in September. The Canadian dollar was weakening against the U.S. dollar from about that time until December, for a number of reasons, said Jason Bonanca, currency strategist at Credit Suisse First Boston in New York. Pension fund managers in Canada are entitled to increase their holdings in foreign-denominated assets on a tax-sheltered basis. These allowed increases are being phased in, and are contributing to a depreciation of the Canadian dollar versus the greenback. A more immediate cause was the slowdown of the U.S. economy, which led to less demand for Canadian exports. But in December, the California power crisis came to a head, and the price of natural gas in U.S. dollars soared, causing the Canadian dollar to appreciate against the greenback. These ups and downs have led to an increase in vol, said Bonanca.