The peso has been pummeled by Donald Trump’s promise to build a wall and make Mexico pay for it.
According to foreign-exchange strategists, risks are now starting to spill north of the border too, where the Canadian dollar is also becoming sensitive to the prospect of the Republican nominee prevailing in the presidential election.
“U.S. politics will remain at the forefront of the markets’ minds from now on, adding an edge to the general nervousness,” wrote Societe Generale SA Global Strategist Kit Juckes in a note to clients on Sunday. “The Mexican peso took all the early impact, but it’s spreading and by Friday it had reached the Canadian Dollar.”
The loonie is commonly described as a petrocurrency, but lately, there are signs it’s more of a petrified-by-Trump currency.
Mr. Juckes’s colleague, FX Derivatives Strategist Olivier Korber, said Mr. Trump’s declaration that he would pull out of the North American Free Trade Agreement threatens not only Mexico’s economic prosperity, but Canada’s too.
“The threat weighing on Canada’s status as a privileged trade partner should be increasingly discounted by FX markets,” wrote Mr. Korber.
While the connection between the Mexican peso and Mr. Trump’s odds is relatively straightforward, you have to look to derivatives to get a handle on how U.S. election risk has migrated north.
Over the last two weeks there’s been a spike in the implied volatility of options on the U.S. dollar relative to the Canadian currency that expire 10 days after the election, and unlike similar dated options for the Australian dollar - another commodity currency - they’ve remained elevated.
This uptick in volatility has coincided with a jump in risk-reversal for the USDCAD pair, indicating that calls for the pair have been outperforming similar delta puts. In other words, traders appear to be positioning for more upside in the U.S. dollar relative to its Canadian counterpart. (The spike back in June was in the wake of the Brexit vote, which hurt currencies everywhere.)
Credit Suisse AG FX Strategist Alvise Marino sees the moves in derivatives pricing as part of a long overdue wake-up call for traders.
Markets “appear much less concerned about the risks to CAD around the U.S. election,” Mr. Marino wrote on July 27, midway through the Democratic National Convention, comparing its risk perception to the peso’s. “We think this represents a key trading opportunity, as we think CAD and MXN are exposed to comparable risks.”
Any election-related pain for the loonie, he added, would be cushioned by the nation’s safe-haven status, as Canada continues to enjoy a AAA credit rating.
“The sharp steepening in FX vol curves at the 2M point suggests markets are starting to price in risk premium about the U.S. election,” said Mr. Marino. “This is particularly evident in the case of MXN and CAD, who would be most likely to suffer from a U.S. shift to a more protectionist trade policy.”
“However, we are starting to see similar dynamics outside of the Americas, suggesting markets are buying optionality in anticipation in of an increase in uncertainty,” he added.
Separately, SocGen’s Korber suggested buying the 2-month call that would allow investors to profit if the U.S. dollar rises above 1.34 relative to the loonie but also stays below 1.40 prior to expiration (plus the cost of the call, minus the cost of the barrier).
This trade allows investors to hedge “the immediate reaction to a Trump victory for three times less than the vanilla cost,” he said.Report Typo/Error