Oil Prices Heavy Impact on CAD Currency

On the 3rd December 2014 the Bank of Canada (BOC) decided to hold interest rates at 1%, a rate of which has been in place since September 2010 owning to the fact that the balance of risks remained within the zone for which the current stance of monetary policy is appropriate.

From the summer of 2014 USD/CAD has been on a firm upward trend rising from around 1.08 to the 1.14 level, a move attributed to two main factors. First, WTI crude futures have seen a dramatic fall since July of this year, having tumbled from USD 100/bbl down to USD 65/bbl as senior OPEC members have been adopting a strategy of forcing prices lower in order to squeeze out the competition from rising shale gas production in North America. Despite calls from smaller OPEC producing nations, such as Venezuela and Algeria, to cut production in order to support prices, the larger names of Saudi Arabia, Iran, Iraq, and Kuwait have remained on the side-lines seemingly happy to see the price of crude oil fall as at current levels it is still not impinging on their fiscal budgets, with Saudi Arabia able to break even with crude as low as USD 10. It is this well-established relationship with all prices which has proved to be a headwind for the CAD and to complicate matters further the USD has recently traded at a 4 and half year high. Secondly, the strength in the greenback has been a prevalent theme with the US economy continuing to show further signs of recovery with the headline change in non-farm payrolls having shown a consistent pattern of +200k job creation.

With oil being a very important factor for Canada, it is worth noting that the relationship is not one-for-one, with analysts at Scotia Bank pointing out that the CAD is vulnerable to downside when oil trades lower but not to collapsing in tandem. Scotia note that oil is down almost 30% from its June 20th high of USD 107.73/bbl while CAD is only down 4.7%, and is in fact outperforming other major currencies. In addition, the recent 80% tumble in WTI oil as we headed into the Vienna OPEC meeting on the 27th of November, had seen the CAD trade essentially flat. Thus, in order to trade the CAD effectively watching the performance of crude oil is essential but is not a relationship that is 100% aligned.

Looking closely at the central bank’s December policy statement, the bank did highlight that inflation had risen more than expected, a concern that has been evident in the most recent CPI reading from Canada, which on 21st of November came in higher than expected at 2.3% for the month of October tracking above expectations of 2.1%. Elsewhere the bank noted that the economy was showing signs of a broadening recovery with stronger exports beginning to be reflected in increased business investment and employment. However, the lower profile for oil and certain other commodity prices will weigh on the Canadian economy, according to the BOC.

The BOC communicates much in a similar methodology to that of other major Western central banks by holding monthly interest rate announcements. However, given that interest rates have been at their current level of 1% for a number of years, it is not the interest rate that is important but the on-going assessment of economic conditions in which the bank releases alongside its rate announcement. Another factor to keep in mind is the need to monitor major economic data out of the US due to the close trade links between the two North American countries. With the market currently pricing in the first rise in US interest rates in September 2015, economic data and commentary from FOMC members is critical in analysing the day-to-day movements of the currency pair. As a guide, analysts at Scotia Bank currently have a year-end target of 1.11 and a 2015 year-end target of 1.13.