Traders Begin to Rethink Bank of Canada’s Divergence from Fed

Updated on
  • Canada 10-year futures print of 12,480 contracts largest ever
  • Wager likely betting that widening yield gap has gone too far

Even as expectations for a Bank of Canada interest-rate hike at Wednesday’s meeting tumble and the outlook for future increases slows, at least one trader appears to be betting that the market’s dovish read is overdone.

Heavy block activity seen in Canada 10-year note futures last week was consistent with a paring of the huge, cross-market wager that was built up toward the end of 2017 and into early 2018 that profited from a widening yield differential with the U.S. The unwinding of the divergence play, and its timing, suggest that some may now be growing uneasy with how little is priced in to the path of BOC policy versus the Federal Reserve.

Strong BOC business survey and employment data over the past two weeks may be fueling speculation the Bank of Canada’s shallow policy path could tilt hawkish relative to the Fed. In addition, U.S. President Donald Trump is pushing for a quick resolution to North American Free Trade Agreement talks, which have entered a so-called permanent round in Washington that’s expected to continue until a deal is struck.

Still, the odds of a hike Wednesday stand at just 20 percent, down from more than 60 percent in late January, according to overnight index swap pricing. And 23 of 25 firms surveyed by Bloomberg expect the BOC to leave rates unchanged. Across the border, in contrast, traders have been gradually ramping up wagers on Fed policy tightening, with banks including Goldman Sachs Group Inc. predicting three more interest-rate increases this year, ahead of even the central bank’s own projections for two.

Last week’s block activity included the largest-ever Canada 10-year futures print -- 12,480 contracts. It coincided with similar activity in the U.S. Treasury note futures, indicating the trade was about cross-country positioning, according to people familiar with the transactions who asked not to be identified because they are not authorized to speak publicly.

Canada 10-year yields slid one basis point to 2.26 percent Tuesday, while the yield on similar-maturity Treasuries was little changed at 2.83 percent. The 57 basis point spread is down from as wide as 71 last month, according to data compiled by Bloomberg. The Canadian dollar has strengthened more than 4 percent against the greenback over the past month, the most of 16 major currencies tracked by Bloomberg.

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