Currency Traders Are Too Complacent About the CUSMA Review

The US dollar has weakened broadly since November, especially against commodity currencies like AUD and NOK. The Canadian dollar has appreciated as well.

In our view, the firmer CAD does not reflect improved confidence in Canada’s macroeconomic outlook. Instead, the move appears to be largely flow-driven. Specifically:

• Speculative traders unwound a large short CAD position, flipping net long for the first time in three years as FX futures positioning reversed sharply (graph 1).
• Canadian pension funds likely increased currency hedges in January, as heightened geopolitical concern—including fears of a “rupture” in the Western alliance—coincided with renewed USD selling.
• High‑frequency data from EPFR, a data analytics firm, shows a surge of inflows into Canadian equities, as some global investors rotated away from crowded US tech exposures and into under‑owned Canadian names.

The Calm Before the Storm

Currency markets have short attention spans. While traders are fixated on broad-based USD weakness, the risk of a negative CUSMA review outcome has quietly faded into the background. Options markets reflect this complacency: USDCAD implied volatility is low, the term structure is flat and the skew continues to favour USD puts (graph 2).

A flat term structure tells us that markets expect volatility to remain low, even as a major policy event approaches. The skew reinforces this message: traders are paying up for bets against the US dollar rather than for protection against a sharp depreciation of the Canadian dollar.

In other words, markets are not pricing in meaningful risk premia for a “no‑deal” outcome—one that could lead to sharply higher tariffs on Canadian exports. For investors with CAD exposure, that is a tail risk worth taking seriously, particularly given how cheap it currently is to insure against adverse scenarios.

Markets are notorious for underpricing even well‑flagged tail risks. On the eve of the Brexit referendum, polling showed voters split almost perfectly down the middle, yet markets were shocked when the “Leave” vote narrowly prevailed. The pound sterling collapsed 10% in a single session.

Don’t Ignore the Asymmetry

Ultimately, the Canadian dollar’s recent resilience appears to be a by‑product of positioning, hedging activity and equity flow rotation rather than a meaningful reassessment of Canada’s macro fundamentals. With options markets signalling calm, implied volatility subdued and traders leaning into further USD weakness, the pricing backdrop looks complacent relative to the stakes of the upcoming CUSMA review. For investors with Canadian exposure, this is an opportunity to hedge tail risks.