What Hedge Fund Extremes Mean for the Canadian Dollar

This currency that I am about to mention has been in the headlines a lot this year for one reason or another. The country has also been in the headlines and not for the best of reasons over the past few weeks.

I am talking about Canada and the Canadian dollar.

The home of the maple syrup, ice hockey, Rocky Mountains and the famous fried potatoes with cheese curds and gravy. I have never been to Canada but after writing that, I am considering it.

As I am writing this out, Canadians are heading to the polls to vote for a new prime minister.

As you may or may not know former prime minister Justin Trudeau resigned this year after his popularity fell due to the rising food and house prices. The liberal party was falling significantly behind in the national polls against the conservatives, that was until US President Donald Trump stepped in and threatened tariffs. In stepped the former Bank of England governor Mark Carney, the new leader of the liberal party. He hit out at the president and defended Canada, bringing a fresh outlook for the party which Canadians seemed to like. Mark Carney is relying on his skills in managing economies to help Canada navigate through economic uncertainty concerning rising living costs as well as ongoing tariff negotiations with Donald Trump.

On the opposite side, we have the conservative party leader Pierre Poilievre. The leader has been in politics since 2004 and has vast experience compared to his opposition Mark Carney. One policy that Pierre Poilievre continues to mention is the cutting of red tape and easing trade conditions of Canada's energy resources of oil and natural gas. He also wants to implicate tax cuts for Canadian citizens, even mentioning having a referendum each time there's a tax increase. He has also weighed in on the Trump saga, stating in a tweet:

Both leaders seemed to be fairly aligned when it comes to their opinions on US President Trump, so this may come down to other policies. What we do know is that a record number of Canadians have come out to vote, which makes this event one for the history books.

But what I want to talk about today is the current hedge fund extreme I have seen on the Canadian dollar futures market. Hedge funds have been loading up on the Canadian dollar, just last week we saw a decrease of short positions by -16,601 and an increase of long contracts by 92, which means net they have increased long positioning by 16,693 contracts.

That's a heavy rise in positioning.

What concerns me though, is the levels they are reaching. The hedge fund's long position has reached similar levels to those of August and September of last year. Canadian dollar futures around that period topped at 0.7400 and fell over 9% to 0.6800. Could the same be on the cards here now?

I like to ask myself the question, why would hedge funds be so aggressively long Canadian dollars, and should I short it?

Let's explore some key factors that impact the Canadian economy:

1. Natural Resources: Canada is rich in oil, gas, minerals and forests. It's probably why US President Trump wants them to become the 51st state. This makes the Canadian dollar vulnerable to commodty prices. Over the past couple of months both crude oil and natural gas prices have been falling, this could weaken the CAD as they hold a strong correlation.

2. Trade Tariffs: As stated earlier it seems either leader is happy to go against President Trump despite over 75% of Canadian exports going to the U.S. A trade war between these two nations could cause commodity price fluctuations and I feel this could have both positive and negative impacts on the Canadian dollar.

3. Interest rates: The Bank of Canada has left rates unchanged in their previous meeting at 2.75%. Uncertainty surrounding tariffs is the main driver here, but if consumers continue to fear tariff repercussions they may hesitate to spend and the BoC may have to cut again.

In my eyes the factors for CAD short outweigh the factors for CAD long, and this extreme could give me a trading opportunity.

As always I have to say that just because the hedge funds have reached an extreme, it doesn't mean the price will turn. When looking at the reports compared with price action, the price is not really at a strong level of resistance. This means we could see the price continue to move in the same direction for now.

The USD futures are also coming into extremes so USDCAD could be a forex pair to watch going forward. Not only this but we can begin to look for strong currencies to pair the Canadian dollar against. NZD is one of those currencies doing well currently. NZDCAD to the upside could make sense if we do see a turning point.

We will likely have to keep up with the data coming out of Canada and the trade negotiations with the US in order to see some significant changes to the macro outlook.

Keep an eye on this one!