Trade: Receive CAD 3m3m OIS at 1.49% - Stop @ 1.6%, Target: 1.24%
Rolls to in 2m to: +16 bps
Rolls to spot in 3m to 3m CAD OIS: +22 bps
(charts are lagged feeds below)
December has seen front-end CAD rates continue to sell-off to where it is now attractive again to receive tactically. Structurally, the Canadian economy is robust, with unemployment rates at record lows and core inflation bottoming; however, front-end rates look expensive given how much can be priced in the near term.
1) Coincident economic indicators are rolling over: Near-term industrial production has peaked from 8% YoY in mid-2017, to 3% currently. Annual GDP has also shed 0.6% to a current 3.0%. According to TD, the fall in IP is attributed an auto-sector related shutdown in October, however, and is expected to rebound strongly in 2018. I think this is slightly optimistic as excluding the auto-sector, manufacturing sales are only up 0.5% for October's month-on-month figure when the overall figure was expected to be up 1.0%.We are also seeing M2 peak, falling 1% YoY from 8%, as well as business credit growth normalizing from stretched levels (3m % change from as high as 16% to a current 9%). In terms of housing, Toronto house price increases have plateaued, recording a 0.7% YoY increase for 2017, ahead of Mortgage tightening rules to be in effect as of the 1st of Jan for 2018, which could be another room for caution for the BoC in terms of hike pacing.
2) Upper-end of near-term hike pricing: OIS fully prices two 25bp hikes by June, and this is likely to be the cap of rate-hiking expectations from the BoC in the near-term with NAFTA renegotiation risks, as well as historical patterns in hiking cycles. The 2010 hiking cycle saw 6m CAD OIS rising 125 bps over the course of 6 months from March; this is a similar magnitude from where CAD rates have surged from June last year to where we are now. The post-08 recovery in inflation and growth were much sharper, and given today's lower inflation regime, I would be attentive as to just how much headline Canadian inflation can perform above 2.0% , which has not been breached since 2014. In addition, using the Fed's hikes as a broad comparison, 2017 saw 3 hikes; any more than 2 from the BoC by June seems like a stretch, even when adjusting for the fact that BoC is at the earlier stage of their cycle than the Fed.
Receiving the 3m3m OIS looks better from an entry perspective where we are currently 5bps higher than Sept's highs, whereas being long BAM8 for example, looks less enticing, as it is hovering above the 98.00 handle in Sept.
Fading the immediate 'over-pricing' in the CAD front-end was something I looked at around August last year, where receiving BoC OIS at Dec (fully priced hike) turned out to fall over 9 bps. I also tried looking at CAD steepeners in IRS with the back-leg further out, which has not been working as I think the 2y point is likely to be the most sensitive point to sell-off most out of the front-end as the market prices rate hikes to be more balanced for pricing further out than the immediate year ahead. In hindsight, a trade that would've been best for this thesis is the 3m3m / 6m6m CAD OIS Steepener, which has steepened +25 bp from the initial surprise in June, having retracements that made sense to re-enter along the way; it's far too steep however for an entry now, justifying the simple 3m3m receive.