C$ strengthens as strong jobs data builds case for rate hikes

The Canadian dollar strengthened on Friday against its U.S. counterpart, recovering from an earlier 1-week low as strong domestic jobs data supported the view that the Bank of Canada will raise interest rates earlier than previously thought.
   
Canada's job growth accelerated in May at its fastest pace in eight months, Statistics Canada said. Employers added 54,500 jobs, handily topping economists' forecast for a gain of 11,000. This is just another piece of information that suggests that the Bank of Canada could be tightening maybe a little bit earlier than markets are pricing. Chances of an interest rate increase this year rose to nearly 30 percent from 22 percent before the jobs report, data from the overnight index swaps market showed.          
 
The Canadian dollar was trading Friday at C$1.3461 to the greenback, or 74.29 U.S. cents, up 0.3 percent. The currency's strongest level of the session was C$1.3454, while it touched its weakest since June 2 at C$1.3545.
   
In other domestic data, industrial capacity rose to its highest level since 2007 in the first quarter, lifted by the manufacturing and construction sectors, data from Statistics Canada showed.                    
    
Prices of oil, one of Canada's major exports, steadied after steep falls earlier in the week under pressure from widespread evidence of a fuel glut despite efforts led by Organization of the Petroleum Exporting Countries to tighten the market. U.S. crude prices were up 0.26 percent at $45.76 a barrel.
   
The U.S. dollar climbed against a basket of major currencies, helped by a bounce in bond yields as risk aversion ebbed following the testimony of former FBI director James Comey.            
   
Canadian government bond prices were lower across the yield curve, with the two-year down 6.5 Canadian cents to yield 0.75 percent and the benchmark 10-year falling 33 Canadian cents to yield 1.454 percent. The 10-year yield touched its highest since May 26 at 1.459 percent, while the gap between it and the U.S. 10-year yield narrowed 1.3 basis points to a spread of -76.4 basis points as Canadian bonds underperformed.
 
We have also seen the foreign exchange options market showing much less risk of a sharp drop in the Canadian dollar than before last November's U.S. election, which could spell bad news for speculators who have heavily shorted the underperforming currency.
 
Bearish bets on the loonie ramped up in May to a record high as Canada's largest alternative lender Home Capital Group Inc nearly collapsed in April.
 
But short-sellers are battling a decline in volatility that has hit stock, bond and foreign exchange markets over recent months and which implies that the Canadian dollar will not fall very far. The decline in volatility could leave sellers sitting on positions that are no longer working and looking for an exit all at once if a positive catalyst for the currency emerges.
 
Canadian dollar sellers are expecting an aggressive Canadian dollar move and the market is saying it is not going to happen. Investors typically pay more in the options market for downside than upside protection in the Canadian dollar because the commodity-linked currency tends to weaken fast when appetite for risk declines.
 
But the drop in Canadian dollar volatility has helped reduce the premium that investors are willing to pay for puts versus calls on the currency, known as the price of a "risk reversal," to a nearly 2-year low.
 
It is more of a risk-on environment than a risk-off environment and people are not afraid that there is going to be a rapid depreciation of the Canadian dollar.
 
A poll last week showed that foreign exchange strategists expect the loonie to dip to C$1.36 to the U.S. dollar, or 73.53 U.S. cents, in the short term but to recover some ground in a year as a strengthening domestic economy encourages the Bank of Canada to prepare the market for interest rate hikes. The currency was trading around C$1.3430 on Friday after strong domestic jobs data.
 
The central bank has not raised its policy rate, which sits at 0.5 percent, since 2010 but struck a more upbeat tone in May than investors had expected. The May meeting was a game changer in terms of viewing the currency pair from a strategic perspective. The grind lower in risk reversals could indicate that market participants have become less bearish on the outlook for the Canadian dollar over the multi-month horizons that contracts in the option market tend to be written.
 
The loonie has been the weakest performer among G10 currencies this year as oil prices fell and the Trump administration started the countdown toward renegotiation of the North American Free Trade Agreement.
 
Investors have also worried that record high borrowing by Canadians will weigh on the country's economy if a red-hot housing market slows.
 
But a positive development for the Canadian dollar, such as a rally in oil prices, could put pressure on often-leveraged speculators to cover short positions and accelerate any move higher in the currency. We are advising our U.S. dollar purchasers to be ready if we go back to C$1.30 because we might get this and it might happen fast.
 
The U.S. dollar rose to a 10-day high against a basket of currencies on Friday, boosted by a weaker British pound after Prime Minister Theresa May's Conservative Party lost its parliamentary majority in national elections.
 
The U.S. dollar index, which tracks the greenback against six major rivals, was up 0.46 percent at 97.364. The index had fallen to a seven-month low midweek on caution ahead of U.S. Senate testimony by former FBI Director James Comey and the British election. But on Friday, it added to gains from the previous session.
 
Comey on Thursday accused President Donald Trump of firing him to try to undermine the bureau's investigation of possible collusion between his 2016 presidential campaign team and Russia, but did not say whether he thought the president sought to obstruct justice.
 
The euro was down 0.24 percent to $1.1185 against the dollar, a day after the European Central Bank closed the door on more interest rate cuts.
 
Traders will turn their attention to next week's U.S. Federal Reserve policy meeting, where the central bank is widely expected to deliver this year's second rate hike. We had weak jobs data last week, but I think they are really on path to hike rates. Everyone will be looking at the verbiage, in particular with the Fed's balance sheet and some of the outlook.
 
Britain's pound tumbled after an election that denied any party a majority in Parliament and fomented a sense of political chaos just days before Brexit talks begin.
 
The result flagged by some analysts as the worst possible election outcome due to uncertainty - caused the pound to fall as much as 2.5 percent to $1.2635 in early European trade, its lowest level since May called the election on April 18.  It recovered a little to trade down 1.68 percent to $1.2733.
 
The Canadian dollar strengthened against its U.S. counterpart, recovering from an earlier 1-week low as strong domestic jobs data supported the view that the Bank of Canada will raise interest rates earlier than previously thought.
 
Technology stocks sold off on Friday, wounding the Nasdaq and holding down other major Wall Street indexes, which had touched record highs earlier in the session.
 
The Dow Jones Industrial Average fell 17.02 points, or 0.08 percent, to 21,165.51, the S&P 500 lost 15.88 points, or 0.65 percent, to 2,417.91 and the Nasdaq Composite dropped 166.89 points, or 2.64 percent, to 6,154.87. Countering tech's slide, financials rose 1.4 percent and energy shares gained 2.3 percent as oil prices moved higher.
 
Investors were also digesting major political and economic events this week in the United States and Europe. U.S. stocks had started the session strong after the results of the UK election, where British Prime Minister Theresa May's Conservative Party lost its parliamentary majority.
 
Investors also viewed former FBI Director James Comey's testimony on Thursday as not damaging enough to Donald Trump's presidency.
 
Market watchers were concerned result of the Congressional hearing could derail Trump's plans for lower taxes, fiscal spending and looser regulations, which have helped drive the S&P 500 up more than 13 percent since his election.