Why the Canadian Dollar Failed to Ride the Oil Price Rally
The relationship between the Canadian Dollar and oil price moves has broken down recently - here CIBC’s Avery Shenfield tells us why.
- Pound to Canadian Dollar rate at time of writing: 1.6083
- US Dollar to Canadian Dollar rate at time of writing: 1.3111
With crude oil prices enjoying a substantial rally this October and subsequently consolidating above the magic $50 area questions are being asked why the same outperformance was not matched by the Canadian Dollar.
Typically higher oil prices advocate for higher a higher CAD as Canada's current account balance is highly dependent on the commodity.
But, the rise in oil prices is said to be built on be based on flimsy foundations by CIBC Economics’ Avery Shenfield - and this has implications for the Canadian Dollar.
The call comes as analysts try and figure out why CAD has largely decoupled from tracking moves in the oil price of late.
“It’s a rally (in oil) for the wrong reasons, of insufficient magnitude, and its role in weakening the exchange rate has been overstated in the first place,” says Shenfield.
One of the “wrong reasons” is the expectation that the deal between Russia and OPEC will deliver a sufficient cap on supply to materially raise the price of oil.
Bank of America Merrill Lynch (BoFAML), for example, forecast a rise to $60 a barrel for WTI crude, partly as a result of the cap, and 60 dollars appears to be near the current market consensus.
However, Shenfield is sceptical oil can rally that much higher on such a flimsy pretext.
“Oil’s rally is a story about a pending supply cut by OPEC, not a signal of accelerating demand. Had it been a demand-pull story, we would historically have seen other cyclical commodities on the mend, but that’s not generally the case,” he argues.
Due to the unilateral nature of the recovery in oil, it will have less of an impact on Canadian exports since the rise will not be accompanied by increases in the prices of key Canadian export commodities such as Copper, Potash, and Uranium.
The rise is not sufficient to increase investment in Canada’s oil sands rigs which were expected to drive exports prior to the decline in crude, but which had to be closed down due to fall in prices which rendered them unprofitable.
In the US, on the other hand, the shale oil industry is already reawakening after a brief slumber now prices are in the $50 range because it is above $50 that most shale oil sites become profitable ventures again.
Shenfield sees the increase in supply from US shale oil as posing a significant threat to global oil prices by meeting demand with fresh supply, and therefore offsetting any rises.
Shenfield argues that regardless of the impact of oil, the Canadaian Dolalr started from an overvalued level prior to its historic plunge:
“A weakening CAD was evident before crude oil took a tumble.
“Oil can’t bear all the blame, because even when we flirted with triple digit WTI prices in 2011-13, Canada was running a large trade and current account deficit. Instead, most of the drop in the Canadian dollar was an overdue correction from an overvalued level attained after the Bank of Canada went solo with rate hikes in 2010."
Bank of Canada (BOC) Meeting in the next 24 hours
The immediate outlook for CAD is dominated by the Bank of Canada (BoC) meeting mid-week.
There is almost a zero percent chance of a rate cut at the BoC meeting on Wednesday, Oct 18.
Shenfield, however, sees a likely dovish tilt to the accompanying statement and speech from governor Poloz, as well as a downward revision in medium-term growth forecasts.
This, combined with the new rules introduced by the BOC to limit mortgage lending, makes it more likely the BOC will cut rates in the future, as they will not have to fear the housing market overheating.
CIBC Capital Market’s Analyst Bipan Rai, sees the possibility that the BOC might take a dovish tone to enact a “phantom cut” in order to purposefully weaken the loonie.
“One way the Bank could do this is by emphasizing the diminishing impact of a weaker currency on exports in its forecasts and the uncertainty around US economy,” argues Rai.
The analyst sees signs the BOC may be harbouring a cautious optimism about the outlook for the economy, due to the high dose of fiscal stimulus and possibilities the resource sector could be bottoming out.
“The Bank likely sees a few signs of cautious optimism.
“For one, Q3 and Q4 growth is expected to be robust (due to the Canada Child Care payments, Federal infrastructure spending and rebuilding following the Alberta wildfires).
“Second, the Bank could highlight the strides made in the resource sector with sentiment indicating that activity is ‘bottoming out’ as per the latest BoC Outlook Survey.
“It makes more sense for the BoC to wait a few more months and then evaluate,” he concludes.
Ultimately mixed views on the tone the BOC takes at its meeting may actually resolve themselves in a neutrally toned delivery.
