Citi goes short USD/CAD. Here’s why

Investing.com -- Citi has recommended a short position in the U.S. dollar against the Canadian dollar, betting that stretched interest-rate differentials between the two countries will reverse in favor of the loonie as upcoming economic data challenge expectations for U.S. monetary policy.

The bank initiated the trade at 1.3854 on Sept. 2, targeting 1.35, with a stop-loss at 1.3990. Citi expects the main driver of the move to be the U.S. dollar leg, as it sees incoming data failing to justify a September Federal Reserve rate hike.

Citi said U.S. inflation data due on Sept. 11 will be the key catalyst, with its economists expecting annual inflation to ease to 2.3%-2.4%. Continued disinflation would reinforce expectations for a neutral-to-dovish stance among Fed policymakers, the bank said, pointing to recent minutes that showed most officials expected inflation to decline over the remainder of the year.

The Canadian dollar also has support from a more hawkish-than-expected Bank of Canada stance. Governor Tiff Macklem said upside risks to inflation had increased and the central bank was prepared to deliver consecutive rate hikes if needed, while playing down the potential growth impact from U.S. tariffs.

Citi said the market’s pricing of the Fed-BoC rate differential is now at the upper end of its range for the year, making it attractive to fade the recent move and position for a stronger Canadian dollar.

The bank also flagged Canada’s first Investment Summit, scheduled for Sept. 14-15, as a potential positive catalyst for the currency. It said announcements around changing investment flows or greater appetite among investors to hedge foreign-exchange exposure could provide additional support for the Canadian dollar.

Citi said the trade also offers a way to reduce exposure to oil-price moves. Higher oil prices can support both the U.S. and Canadian currencies through improved terms of trade, particularly amid renewed U.S.-Iran geopolitical risks. Short USDCAD therefore allows the bank to retain exposure to a potential removal of the Fed’s hawkish premium while limiting the impact of the currencies’ shared oil sensitivity.

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