USDCAD highly correlated with the two-year interest rate differential - BBH

Analysts at BBH suggest that Canada illustrates a broader issue, and that is the significance of interest rate differentials, which is a way to quantify a dimension of divergence.  On a purely directional basis, the US dollar-Canadian dollar exchange rate is highly correlated with the two-year interest rate differential, they further add.  

Key Quotes

“Over the past 60 sessions, the two have moved in the same direction a little more 90% of the time.”  

“The US dollar fell against the Canadian dollar from early May's high close to CAD1.38 to near CAD1.21 in early September.  The greenback has recovered in recent weeks and moved toward CAD1.2625 before the weekend.  About a week after the US dollar peaked in early May, the US two-year premium peaked near 65 bp.  As the dollar was tumbling, the differential swung to a discount of 25 bp by early September.  The US premium, now a little more than 11 bp, has been restored, and the US dollar appears set to recoup its earlier losses.”  

“Another broad point that the Canadian dollar helps illustrate is market positioning.  We use the non-commercial positioning in the futures market as a proxy for short-term speculative, momentum, and trend following players.  This market segment is going into the meeting with a substantial long bias.  The net long position of almost 74k contracts is nearly the most in five years.  The gross long position of 94.5k contracts is about 10% below its recent peak, which itself was the highest since 2012.”