Hedge fund managers rushed to short the Canadian dollar in the fourth quarter of 2024. The assumption was that a faster U.S. growth rate would divert foreign investment away from Canadian dollar assets. Things have not gone as planned.

The short loonie trade was profitable for a time as the domestic currency fell from US$0.74 on October 1 2024 to US$0.69 in early March of this year. From that point, however, shorting the Canadian dollar became a losing proposition as it has rallied to more than US$0.72.

The chart belowshows the total short futures position for the loonie as reported by the U.S.-based Commodities Futures Trading Commission. It indicates sentiment but as far as hedge fund positioning it should be viewed as merely the tip of the iceberg. There are many ways to express a loonie short position – borrowing funds in Canadian dollars to buy U.S. assets is among other options.

Scotiabank chief foreign exchange strategist Shaun Osborne sees the potential for a short squeeze that would push the loonie sharply and quickly higher.

He notes that speculative short positions on the U.S. dollar more than doubled during the week ended on April 15 – the net short position in the U.S. dollar versus the loonie, Japanese yen and euro combined rose by US$6-billion to US$10-billion.

Short Canadian dollar positions are the largest among countries reporting data, “leaving it vulnerable to continued adjustment in an environment of broad-based USD weakness,” according to Mr. Osborne.

A rapid change for the worse in U.S. dollar sentiment combined with bloated and now offside short positions on the Canadian dollar is a recipe for a rapid jump in the loonie. Speculative investors that are short the loonie may have to cover the positions (including repaying any Canadian dollar loans) in a hurry if the U.S. dollar continues to fall and increase the losses on the trade.

Source: The Globe and Mail