Hedge funds have increased their bearish positioning against the Canadian dollar to one of the highest levels in 20 years, despite expectations that the Bank of Canada will raise interest rates for the first time since July 2023, according to a report by FXStreet.

Commodity Futures Trading Commission (CFTC) data shows leveraged funds held a net short position of approximately 91,000 Canadian dollar futures contracts, worth C$9.1bn, as of 20 October. The position has more than doubled from 39,000 contracts in mid-September, with only ten weekly observations since 2006 recording larger bearish bets.

The positioning comes as markets price in an approximately 80% probability that the Bank of Canada will raise its benchmark interest rate from 2.25% to 2.50% on Wednesday. Hedge funds appear to be betting that any tightening will be short-lived, as weakening economic conditions constrain the central bank's ability to deliver further increases.

Canada's economy lost 110,000 jobs across August and September, while unemployment rose to 6.5%. Although headline inflation reached 3.1% in September, largely driven by higher gasoline prices, the central bank's preferred underlying inflation measures remained below its 2% target.

Institutional investors have taken a different approach, with asset managers, pension funds and insurers reducing their aggregate net short position from approximately 105,000 contracts in August to just 5,400 by 20 October.

Attention is now focused on the Bank of Canada's updated inflation forecasts and guidance on future monetary policy. A more hawkish outlook could trigger a significant short squeeze as hedge funds unwind bearish positions, while indications that further rate increases are unlikely could reinforce existing bets against the currency.