The reality of higher interest rates
- Posted by Richard Croft on July 6, 2007 filed in Options Market
Bad news for banks makes it a good time to buy
Higher Canadian interest rates appears to be a foregone conclusion. Most analysts believe that the Bank of Canada will raise rates 50 basis points next week. It is something I have not been inclined to believe. But given the stance of so many economists, it is getting harder to swim against the tide.
It is not so much that we are experiencing severe inflation. The Bank of Canada is simply worried about potential inflation driven by extraordinary growth.
The jury is out whether that is a real concern. But at this stage, it appears the Bank of Canada is not willing to take chances.
The first rate hike is for show. The market has already priced it in, and the follow through will let the world know that Canada is serious about fighting inflation. Politics is, after all, a part of economics.
The second rate hike, which will almost surely follow, tells Canadians that the Bank of Canada is serious about slowing Canadian growth. This is the move that really counts.
Assuming this scenario plays out, the loonie will move higher. Especially when you pair a rate hike here with stable US rates and a weakening US dollar. I expect the loonie will be on par with the US dollar by the end of the year. Perhaps sooner!
On the positive side, once the hikes are out of the way, we will begin to see some strength in the Canadian banks. Seems strange that banks might gain strength when rates are rising. But in reality, the market has already taken its pound of flesh out of their share price based on the perception that rates might rise. Perception becoming reality is a signal to buy on the bad news.
Calls on banks are still cheap, which makes buying them a good way to play the bad news scenario.
July 13, 2007 at 9:21 pm
How much potential is there in USX. Haven’t they already priced the interest rate action in the current price?
July 9, 2007 at 1:03 pm
If you are purchasing USX options you are betting on the direction of the US dollar. Since we are anticipating a rise in the Canadian dollar, we would be looking for the US dollar to decline, so buying puts would be the appropriate strategy. Generally, I prefer to buy at-the-money options because I find those are the most liquid and tend to be the most efficiently priced.
The MX offers two symbols for USX (due to lack of strike price alpha codes). Under the symbol USZ; you will find strikes from 104.50 to 108.00. Under the symbol USX; you will find strikes from 108.00 to 119.50.
With that in mind I would look at the USZ August 105 puts, recently priced at $1.18.
July 7, 2007 at 12:40 pm
Great Article….Thanks.
Assuming the scenario plays out as you predict, what would you recommend in terms of a strike price and delivery month for someone interested in purchasing a USX put on the Montreal Exchange to capture the continuing rise of the Canadian dollar?