An Oil Price Headache: Canadian Dollar Outlook Downgraded at Bank of America

Forecasts for the CAD have been lowered by analysts at Bank of America Merrill Lynch Global Research as lower-for-longer oil prices are factored into the currency equation.

Commodity strategists at BofA warn that a further selloff in oil prices can be expected given the lack of short-term elasticity of supply.

We have noted here on previous occasions that the impact of oil prices on the Canadian exchange rate complex cannot be underestimated.

Indeed, the decline of Canada’s most crucial commodity in recent months has allowed the USD to take advantage and climb.

That said, keep in mind that the pound to Canadian dollar exchange rate (GBP/CAD) shows no signs of exposure to the oil price.

Those looking for guidance on sterling-CAD should rather focus on technical indicators as a guiding factor.

Lowering the Forecast on USD/CAD

“The lower-for-longer level of oil prices our energy team now expects prompted us to push up our USD-CAD forecasts to 1.26 by year-end (from 1.11) as the low level of oil prices will challenge Canada’s high-cost energy sector,” says Ian Gordon, FX Strategist at BofA.

Furthermore, on the back of the oil forecast change, economists have also downgraded their Canadian growth forecasts, and pushed out the timing of the first BoC hike to 3Q16.

“This contrasts with the above-3% US growth profile we expect and expectation for a Fed hike in September 2015, pushing relative growth and policy stances in the US dollar’s favour,” says Gordon.

Analysts do however caution that while no rate hikes will be forthcoming from the Bank of Canada currency markets would be wrong to push CAD exchange rates lower on expectations for rate cuts.

“The C$ has depreciated notably since the BoC’s 3 December meeting, and the 5yr rate has continued to drop – marking a major easing in financial conditions. Why cut rates when the market is already doing all the work?” says a note from Bank of America.

Uncertainty is the Only Certainty

For a central bank that has gone out of its way to highlight uncertainty in its forecasts, the recent drop in energy prices makes it even harder for the Bank of Canada to have any clear sense of the outlook.

Weaker oil prices are “on the whole to be bad for Canada,” as expressed in Deputy Governor Tim Lane’s 13 January speech.

“However, there are important cross currents in this view. Weaker oil prices will hurt the energy patch, but the associated C$ depreciation and stronger US trajectory will support exporters, especially manufacturers,” says Gordon.

Lowered Forecasts

Commenting on the outlook, BofA Merrill Lynch see the following exchange rate levels ahead:

“The continued fall in WTI to US$31/bbl in 1Q that we forecast will continue to keep CAD under pressure, overwhelming any post-meeting disappointment. In addition, while interest rates have moved in the CAD’s favor recently, we see the decline in US yields that has driven the move as overdone. As yields normalize, USD-CAD will continue its march higher.

“Therefore, we would fade any CAD strength on the back of a cautious but balanced statement with oil prices implying USD-CAD will move to 1.28 by 3Q before falling to 1.26 into the year-end."