Canadian Dollar net short positions rose about 36%, reaching their highest level since December 2025, according to Rabobank. The CAD was the second-worst performing G10 currency in May, as positioning weakened alongside softer domestic data.
In Q1, Canada’s GDP slipped to -0.1% q/q annualised, a reading consistent with a technical recession. Even so, markets continue to price around 1.25 Bank of Canada hikes by year end, implying expectations of further monetary tightening despite the contraction.
Bearish Market Sentiment and Positioning Risks
Given the high level of short positions against the Canadian Dollar, we see a market that is heavily biased towards further weakness. This sentiment is backed by Canada entering a technical recession with a -0.1% Q1 GDP print. The CAD’s poor performance in May reinforces this bearish outlook for now.
The main puzzle for us is the market pricing in 1.25 interest rate hikes from the Bank of Canada (BoC) by year-end. This suggests a major conflict between poor economic growth and persistent inflation, which the latest CPI data for May 2026 confirmed was holding at a stubborn 3.1%. This divergence between economic data and rate expectations is creating a tense environment for the currency.
For the coming weeks, we believe traders should consider buying put options on the CAD to follow the bearish momentum. This strategy limits risk while capitalizing on the negative sentiment, which was further supported by last week’s jobs report showing the unemployment rate ticking up to 6.3%. The recessionary data makes it difficult for the BoC to justify the hawkish stance the market is pricing in.
However, the risk of a significant short squeeze is now extremely high. We would therefore buy cheap, out-of-the-money call options as a hedge or a speculative bet on a surprise from the BoC. We recall a similar setup in late 2024 when crowded shorts in the Japanese Yen were forced to cover rapidly after a minor policy shift, causing a sharp rally.
Event Risks and Volatility Strategies Ahead of BoC
All eyes will be on the next Bank of Canada policy meeting on July 10th. This event will likely be a major catalyst that could either validate the bearish trend or trigger the feared short squeeze. The tension between the recession and inflation means a significant price move is almost certain.
Therefore, we see value in strategies that profit from rising volatility, such as a long options straddle. This involves buying both a call and a put option with the same strike price and expiry date. This position will be profitable if the CAD makes a large move in either direction following the July BoC meeting, removing the need for us to correctly guess the outcome.
