Bearish Oil Breakdown Spotlights Pound-Canadian Dollar Move Lower

© Faithie, Adobe Stock

Crude oil has broken through a key level following supply glut fears, and this is providing a further headwind to the Canadian Dollar.

Oil is breaking below a major trendline, suggesting an increasingly bearish outlook, according to Adam Button, an analyst at Forexlive.com who's been stalking the commodity for some time now.

"Technically, oil is below the trendline from the past year. It's down $1.51 (or 2.25%) to $65.54 as the week winds down," said Button on Friday.

Since then WTI Oil has stabilised a bit and is trading only a pip lower at $65.53, at the time of writing, on Monday, June 4, yet it's still vulnerable to further declines, especially if the price breaks back down below the 65.23 lows of the day.

As any technical analysts worth his salt will tell you a major trendline break is an extremely bearish sign with the price expected to fall an equal distance below the trendline as the length of the move immediately prior to the break, which in this case suggests a downside target of potentially as low as $60.00.  

From a fundamental perspective, the sell-off has been put down to comments from OPEC chair Saudi Arabia, along with Russia, that they may remove the production cap which they previously imposed to limit supply and drive up prices in 2017.

Their reasoning is that it is no longer necessary as geopolitical factors are limiting supply organically as a result of sanctions on Iran and the collapse of Venezuelan production due to hyperinflation in the economy.

Another factor pushing down oil prices is the rise in US production which reached a monthly all-time record high of 10.47 million barrels a day in March.

The US rig count has also shot back up to 861  - the highest its been since 2015 - as oil prices have risen to above the breakeven rate required to make fracking profitable.

A summer seasonal uplift effect is unlikely to stall the decline because of the plentiful supply.

"We are going into summer, the high demand season, and I think we are going to see a fall in U.S. crude oil inventories, but shale oil output is growing," says Tony Nunan, risk manager at Mitsubishi Corp.

Longer-term the price of oil could fall to $55 per barrel, according to analysts at CNBC.

"The production cut will not go on forever, and the oil market cannot sustain current prices when OPEC and its partners return to normal production levels," says Osama Rizvi, a freelance journalist writing for Oilprice.com.

"The market requires a continued rise in demand from emerging economies and a pullback in shale production if it is going to maintain higher oil prices once the OPEC deal does come to an end," he adds.

"An analysis from CNBC follows this logic and comes to the conclusion that WTI might fall to $55," concludes Rizvi.

Impact on Pound vs. Canadian Dollar

Given the pretty bearish verdict on crude, what is the impact on FX likely to be?

Crude influences the following major currencies predominantly: CAD, RUB, NOC, INR and to some extent JPY. The first three are the currencies of major oil producers and are positively correlated to crude, the last two are major oil importers and are negatively correlated to the price of crude.

GBP/CAD is rising, revealing CAD weakness in line with our view of trends in the oil market. It also appears to be attempting to reverse trend and resume its previous long-term uptrend. A green bullish day today (Monday) would complete three up days in a row which is a mildly bullish reversal signal, a long green bullish day would produce a stronger 'three white soldiers' signal.

The weekly chart below shows the pair was in an uptrend longer-term but has now pulled back down to the midpoint of the previous rally and looks like it is stabilising.

This sort of market activity usually accompanies resumption of the uptrend after a correction, suggesting the outlook for Sterling against the Canadian Dollar might be improving.  

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