Canadian Dollar Weakness Unlikely to Last Despite Trump's Attack on OPEC

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- CAD weakens after Trump hits out at OPEC over oil price rise.

- But oil is going higher and will support CAD some analysts say. 

- As others eye scope for BoC hikes to also lift CAD later in 2019.

The Canadian Dollar was sent lower after U.S. President Donald Trump lashed out at the Organization of Petroleum Exporting Countries (OPEC) over the manipulation of oil prices, sending crude oil benchmarks lower. Oil is a key foreign exchange earner for Canada and with the country's currency showing an increased correlation with the commodity of late the decline in CAD alongside was unsurprising, even though analysts say both will rebound before long.

President Trump said in a Twitter post that oil prices have risen too high and urged OPEC to "take it easy" with its production cuts as "the world cannot take a price hike". The comments came at a time when both Brent and WTI oil benchmarks were sat on gains of nearly 25% for the year-to-date. 

Oil prices getting too high. OPEC, please relax and take it easy. World cannot take a price hike - fragile!

— Donald J. Trump (@realDonaldTrump) February 25, 2019

Oil prices have risen sharply this year after OPEC and Russia agreed in December that they will reduce production from across the bloc by 1.2 mn barrels per day for the first six months of 2019, in order to "balance the market", which is widely seen as a euphemism for manipulating prices higher.

That stemmed and eventually reversed a double-digit decline in the prices into the New Year, although U.S. sanctions against Iran and Venezuela have also stoked fears of a possibly dearth of supply later in 2019. 

"Trump expressed displeasure at the (higher) price of oil and the market duly humoured him by taking Brent prices back down to $64.70p/b," says Kit Juckes, chief FX strategist at Societe Generale. "On the supposition that oil prices are settling into a broad range whose centre of gravity is above the current price, I still think EUR/NOK and USD/CAD will be somewhat lower by mid-year."

Above: WTI crude oil price shown at daily intervals alongside USD/CAD rate (orange).  

Oil and its refined derivatives are among Canada's largest exports so changes in prices are always important for the value of the Loonie. However, Trump's intervention means there is now uncertainty around the outlook for oil.

"The price action yesterday suggests the market believes OPEC will take note of these comments and there is some basis for this. This has certainly been the case in the past, despite the defiance in December. If further plans to cut supply are moderated by increased pressure from the Trump administration, it will create less supportive environment for oil currencies like CAD and NOK," says Lee Hardman, a currency analyst at MUFG. 

If President Trump's pressure on OPEC further undermines prices during the months ahead then he will be chipping away at about the only source of fundamental support currently enjoyed by the Loonie, which has been caught between the push and pull influences of a deteriorating relative-interest rate outlook and the oil market recovery.

Some analysts say that current levels for major oil benchmarks mean the Canadian Dollar should be a lot higher than where it is currently, although once interest rate differentials are taken into account the supposed "fair value" for the Loonie then declines. 

"Utilizing 2Y and 5Y spreads as the only inputs into our model USDCAD equilibrium is set around 1.3560. Using commodity-centric inputs – crude oil, the Thomson/CRB index and Canadian terms of trade – shifts Fair Value down to 1.2943. The usual blend of spreads and crude oil that we use suggests a modest USD undervaluation, with equilibrium near 1.3310," says Shaun Osborne, chief FX strategist at Scotiabank, speaking of the USD/CAD rate. 

Above: USD/CAD rate shown at daily intervals.

Pricing in overnight-index-swaps markets implied an October 30, 2019 cash rate of just 1.82% on Tuesday morning, suggesting investors see only limited chance of even one Bank of Canada interest rate rise coming inside of 2019. The current cash rate is 1.75%. 

Previously, in early December 2018, markets were betting the BoC would lift its interest rate to at least 2.25% this year, implying two rate hikes, and there was speculation among analysts about a possible third rate rise too. 

However, the BoC took itself out of the rate hike game in January, citing a more uncertain outlook for global trade, uncertainty over businesses' appetite for investment and a desire among policymakers to observe the effect that past hikes are having on households before moving again. 

It's official guidance is the bank will be patient before hiking interest rates again and that when it does begin to lift the cash rate the next time, it will move much more slowly than it did before. The BoC hiked rates three times in 2018 and twice in 2017. 

"We are medium-term CAD bulls anticipating further strength and fresh 2019 highs on the back of a continued improvement in Canada’s terms of trade and an increasingly constructive BoC guiding toward further normalization in the latter half of 2019," says Scotiabank's Osborne. 

Above: Pound-to-Canadian-Dollar rate shown at daily intervals.

The Bank of Canada's shift to a more neutral interest rate stance came at exactly the same time as the U.S. Federal Reserve said it too would be "patient" before lifting rates again. However, not all analysts are buying into the idea of a prolonged BoC pause. 

Scotiabank's Osborne is looking for a strong domestic economy to encourage the BoC to become more "hawkish" later in the year, which would lift the Canadian Dollar particularly against currencies where that turn in rhetoric is not matched by a similar shift from the respective central banking counterpart. 

"We remain bullish on CAD on crosses such as against NZD," says Hans Redeker, Morgan Stanley's head of FX strategy. "The Canadian labor market continues to tighten, growth momentum looks firmer with wholesale trade, business confidence, and existing home sales all printing above expectations. More robust growth coupled with firm oil prices and a tight labor market should give the BoC sufficient reason to turn more hawkish, supporting CAD."

Redeker and Morgan Stanley have advocated that clients sell the NZD/CAD rate, targeting a move down to 0.84 over the coming weeks, which is the same thing as a recommendation to buy the Loonie. They are also forecasting that the USD/CAD rate will fall to 1.28 by year-end. 

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