Canadian Dollar "Risks Skewed to the Downside": Barclays

Above: Canadian oil sands, image © Adobe Stock.

The near-term outlook for the Canadian Dollar is "skewed to the downside" according to foreign exchange analysts at Barclays.

In a regular weekly currency strategy briefing note, Barclays says the two successive disappointing Canadian labour market data releases could prompt the Bank of Canada to ease back on its interest rate hiking agenda, while an ongoing decline in oil prices could also weigh.

Last week official data showed Canada posted its second consecutive decline in employment in July with a -30.6k reading, which was less than the consensus forecast for growth of +15k jobs.

The unemployment rate nevertheless remained near long-term lows at 4.9% and wage growth remained resilient, growing at 5.4% year-on-year.

Economists at Barclays therefore see mixed signals from the report: while July’s job decline was more notable across sectors than the June fall, the drop in the participation rate suggests that the lack of supply of workers could have played an important role (as opposed to pure weakening demand).

Ultimately for the Canadian Dollar, what matters is how the jobs report impacts Bank of Canada policy; specifically how many further interest rate hikes they intend to deliver.

Above: GBP/CAD (top) and USD/CAD (bottom) at weekly intervals, showing 2022 performance.

Currency strategists at Barclays say although there are signs of a cooling labour market, the decline in the participation rate amid resilient wage growth suggests the labor market remains 'tight'.

Labour market tightness refers to the situation where there is not enough labour available for the jobs posted by employers, creating upward pressures on wages and, ultimately, inflation.

It is therefore a key determinant of whether a central bank believes it necessary to raise interest rates.

"As such, we retain our view that the BoC will moderate its pace of hiking from 100bp in July to 75bp in September and 50bp in October, and end the cycle at 3.75%," says Barclays.

Strategists do however see risks that the BoC could end the cycle earlier and at a lower terminal rate if tighter financial conditions hurt domestic growth and inflation more than we expect.

Such an outcome would potentially disappoint against market expectations, weighing on the Canadian Dollar in the process.

Therefore the Canadian Dollar "could remain under some pressure this week," says Barclays' FX strategists.

Furthermore, they add, the ongoing decline in oil prices could add to this downside pressure.

Above: U.S. TWI oil prices, showing the recent pullback from the post-invasion highs.

Oil benchmarks are now in their third month of decline, with the U.S. TWI falling 8% in June, 7.20% in July and a further 8.30% already in August.

Canada's trade balance relies heavily on the positive input from oil exports, therefore further falls in prices would lower foreign currency earnings.

A stabilisation in oil prices would therefore be seen as supportive, however further declines would suggest further external headwinds for the currency.