Some strategist think the Bank of Canada is likely to hike interest rates more quickly than the Federal Reserve leading to opportunities for swaption traders, while others think the two central banks will move in tandem.
The interest rate differential between the U.S. and Canada will widen making derivatives, such as cross-currency swaptions, a more lucrative investment, said Commerzbank market strategist, Robert Gay. "The Fed will pause in December despite the strong employment report and Canada will go on its merry way," he said, predicting the Canadian dollar, which recently broke through its technical trading point of CAD1.25 and reached a 12-year high, will remain strong thanks to oil prices and the long-term foreign investment.
Gay thinks traders will develop structures using cross-currency payer swaptions and zero-premium swaptions so they don't suffer losses from time-decay. "We have one we're recommending now, but it's not published yet," noted Gay. And it may force China to finally revalue the yen because the cost of commodities will have become phenomenally expensive, he said. "That would be a major event for most bond markets" (see related story, page 4).
John Rothfield, a senior currency strategist at Bank of America, disagrees. Bank of Canada's short-term interest rate stands at 2.5% versus the Fed's 2%. In addition, the market is predicting that in the next 12 months the Fed funds rate is rising more aggressively than the Bank of Canada, said Rothfield. "So there is no significant case to be made for the interest rate differential widening," he said.
Greg Anderson, a senior currency strategist at ABN AMRO, thinks the Canadian dollar will appreciate to CAD1.15 in the first quarter of next year. He also predicts the Canadian bank will hike interest rates twice more this year while the Fed will hike U.S. rates once more.
