When the Bank of Canada eases monetary policy and the economy slows, money managers usually brace for a weaker loonie.

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Yet, the Canadian dollar is fresh off its best monthly gain so far in 2024. And options traders expect it to rally even more despite the country’s gloomy economic outlook — the unemployment rate is at its highest in two years and consumers are strained, racking up credit card balances. Those conditions have the Bank of Canada poised on Wednesday to cut interest rates for a third-straight time this year as it moves to lower borrowing costs.

Last week, options traders were the most bullish on the loonie in 15 years, placing wagers that the currency will advance further versus the dollar over the coming month. Much of the optimism stems from the greenback’s lacklustre performance.

“The dollar’s broad-based decline is doing the bulk of the work in driving the loonie higher, but a number of idiosyncratic factors are also providing lift,” said Karl Schamotta, chief market strategist at Corpay in Toronto.

A recent near-record wager against the loonie is prompting some investors to position for an even bigger rally if traders decide to cash out. Hedge funds and asset managers still hold a roughly US$8 billion short bet against the Canadian dollar in the latest Commodity Futures Trading Commission data for the week through Aug. 27, down from a peak of US$14 billion earlier in August.

“Bearish speculators are capitulating, suggesting that early-August’s historically extreme short position on the Canadian dollar could be largely unwound,” said Schamotta.

The Canadian dollar climbed 2.3 per cent last month versus the greenback, compared with an average negative return of 0.2 per cent for August over the past 25 years. Since hitting its 2024 trough on Aug. 5, the loonie rallied past its 50-, 100- and 200-day moving averages in under three weeks.

Despite the loonie’s impressive run up, the currency is kicking off this month lower by about 0.4 per cent. It is still down 2.3 per cent this year and is among the biggest losers of developed-nation currencies tracked by Bloomberg. The under performance has prompted options traders to expect further gains in a catch-up move.

Last week, traders were paying more for put options that bet on a lower greenback versus the Canadian dollar than for calls that look for the pair to rise — an anomaly not seen since the global financial crisis. One-month risk reversals, which measure the difference between call and put options, dipped below zero at one point to levels last seen in October 2009, according to data compiled by Bloomberg — although they have since recovered to trade above parity.

Despite the bullish sentiment, the loonie could be the most vulnerable among Group-of-10 peers to a rebound in the dollar, according to Charu Chanana, head of FX strategy at Saxo Markets in Singapore, adding that yield differentials are not in favour of the loonie.

For now, the Canadian dollar is trading outside of 1.31 to 1.32, a range it has struggled to reach over the last two years. That means the loonie is not facing any near-term serious headwinds and could build off the recent momentum, rising another two per cent to three per cent, according to data compiled by Bloomberg.

Bloomberg.com