- Cost for volatility insurance higher a week out than a month
- Latest polls show Liberals may oust Harper to form government
Currency traders are starting to get nervous about Canada’s election next week.
They’re paying more for options contracts that protect against currency swings expiring next week -- the aftermath of Canada’s Oct. 19 vote -- than for similar contracts that expire in a month, data compiled by Bloomberg show.
Normally, the further out a contract’s expiry the more it costs because that’s more time for something unexpected to happen. The current inversion of that relationship suggests the market is more interested in protecting against the immediate unknowns next week.
The latest polls suggest Canada’s majority Conservative government led by Prime Minister Stephen Harper could be replaced by a minority Liberal government, according to poll tracking website ThreeHundredEight.com. A minority government would need support from other parties to stay in power. Investors also face the uncertainty of a Bank of Canada rate decision Oct. 21, two days after the vote.
"There’s an election next week and that’s the story here," Greg Anderson, global head of foreign-exchange strategy at the Bank of Montreal, said by phone from New York. "If there is a transition in government, what does this mean? What are the changes in policy going forward?"
It now costs 9.3 percent to protect against swings in the Canadian dollar versus its U.S. peer over the next week, compared with 9.1 percent for the same protection spanning the next month, the data show.
That comes after a bout of strength in Canada’s currency lifted it off its lowest point in 11 years. The currency rose four of the last five weeks as prices for crude oil, one of the country’s largest exports, strengthened.
The loonie, as the currency is known for the image of the aquatic bird on the C$1 coin, now trades at 1.2977 per U.S. dollar, or about 77 U.S. cents, according to Bloomberg data.
Though every forecaster but one expects the central bank to leave its benchmark rate unchanged at 0.5 percent, any changes in the economic outlook released along with the rate decision could stir up volatility in the currency. The Bank of Canada has already cut its benchmark rate twice this year.
The combination of the election and the interest rate decision makes next week a particularly important one for Canada in the international markets because its national accounts have more money going out than coming in, and so it relies on borrowing money from abroad to make up the difference.
A change in government, or a change in the make up of government, could be occasion for international investors to re-evaluate, said Bank of Montreal’s Anderson. Front-runner Justin Trudeau of the Liberals has pledged to boost spending to spark growth, running deficits of about C$25 billion ($19 billion) over three years. Harper and the New Democratic Party have promised to balance the budget.
In a report Tuesday, Canaccord Genuity Group said a Liberal victory “could mean further Canadian dollar depreciation and higher bond yields,” with a risk that those deficits could become permanent.
"Typically transitions are negative for currencies with current account deficits, because you have foreign investors who need to fund the deficit," Anderson said. "You’re always dealing with a dearth of information. You’ve got a new government. What are they going to do? What’s going to change? Do I still want to lend to this country?"