Global "fast money" hedge-fund investors have rapidly removed bullish bets on the Canadian dollar and are now, in aggregate, betting on a weakening loonie in the weeks ahead. Thankfully, hedge-fund positioning has been a lagging indicator for the domestic currency – they respond to what has happened to the loonie previously rather than predict what's ahead – and the most effective indicators of the loonie's value suggest the dollar is fairly valued.
The Chicago-based Commodity Futures Trading Commission reports weekly on speculative futures positioning in a wide variety of asset classes including energy, metals, agricultural commodities and currencies. In each case, the report is split between total "commercial" contracts outstanding – this includes energy producers using futures markets to lock in the price for future oil sales – and "non-commercial." The latter is widely used as a proxy for hedge fund bets.
The most recent CFTC report included a large drop in bullish hedge-fund bets on the loonie. The net positioning – total long bets minus total shorts – fell from 7,333 contracts to minus 1,025 contracts (figures in negative territory indicate more short interest than long interest).
The first chart below compares the net hedge-fund futures position with the value of the loonie in U.S. dollar terms. The recent shift appears to have been led by the currency. The Canadian dollar began dropping on May 12 first, followed two weeks later by the decline in bullish sentiment in futures markets. This suggests that, for now, the increased pessimism on the loonie by hedge funds is a response to losing money on previous bullish bets, not a prediction of significant currency weakness to come.
Global growth expectations and commodity prices have been the best forward-looking indicators for the domestic currency in the past 18 months. In both cases, the loonie seems fairly valued at current levels.
The middle chart shows the Canadian dollar's progress against the Citi Commodity Terms of Trade Index, which represents a weighted measure of the prices for commodities Canada exports most. Based on five years of data, the loonie is very much in line with current commodity prices.
As a resource-rich export economy, Canadian growth is extremely sensitive to changes in global activity expectations, as the bottom chart highlights. Consensus estimates for 2015 global gross domestic product growth have been arguably the best forward-looking indicator for the loonie's value – the dollar has followed the course of growth estimates with an approximate one-month lag. And, just as with commodity prices, the Canadian dollar appears fairly valued relative to growth expectations.
I don't think the hedge-fund pessimism reflected in futures markets is anything to worry about in the near term. The loonie looks neither cheap nor expensive based on current resource prices and global outlook and until things change, significant moves in the Canadian dollar appear unlikely.
Follow Scott Barlow on Twitter @SBarlow_ROB.