CAD V’s USD: Fundamental Strengths and Weaknesses

The USD/CAD Pair Depreciates Sharply in February

The Canadian dollar has shown incredible resolve in its uphill climb against the greenback since the middle of January 2016. The loonie was trading at over 1.46000 to the USD barely a month ago, but has since clawed its way back to 1.35116, and restored confidence back in the Canadian economy. There are several important upcoming economic announcements that will have a bearing on the performance of the USD/CAD currency pair including the 1:30 PM GMT announcement on Canadian GDP with expected year-on-year growth of 0.0% and quarterly growth for Q4 2015 expected at 0.1% with a previous level of 2.3%. On Wednesday, 2 March at 3:30 PM GMT, the DoE US crude oil inventories will be announced with a previous figure of 3.52M barrels as at Friday, February 26 2016. These announcements will have an impact on the USD/CAD currency pair as the performance of the Canadian economy is closely linked to crude oil prices and major economic announcements from its main trading partner – the US.

The correlation between the strength of the Canadian dollar and the price of crude oil remains intact; there has been a significant weakening of this relationship since the beginning of 2016. This is evidenced by a strong appreciation of the Canadian dollar against the greenback and other G-10 currencies in spite of the plunging prices of crude oil. The correlation was previously at -0.926, and it is now at -0.638. The closer the correlation is to 1, the more perfect the price movements. A negative correlation indicates that as the price of oil declines, the equal but opposite reaction will be felt with the Canadian dollar – it will appreciate. The further away from 1 the figure is the weaker the association. The alignment between price movements with respect to crude oil and the CAD has weakened in the past 60 days, and this trend looks set to continue as the CAD charts its own course more independent of the price of crude oil. That the CAD has continued to move towards parity with the USD is a big pat on the back for a currency which has been hammered as a result of crude oil weakness.

 

The CAD has been testing a level of 1.3500 against the USD during multiple trading sessions, and dollar weakness against the currency is pervasive.

There is a narrowing in the yield between the Bank of Canada and the Federal Reserve Bank, and market analysts are expecting a close correlation between the policies of both banks. In another surprise move for the Canadian economy, inflation figures have generally held their own, owing to strong exports from Canada. The 2-year yield is now down to -26.4 from -60. In spite of differences in interest rates between the banks, another upwards revision of the US interest-rate would likely have little impact on the Canadian dollar. The CAD is largely expected to strengthen against major currency pairs such as the British pound, the Euro, the Japanese yen and others. Fears of a Brexit are looming large on the horizon, and the closer it comes to June 23, the weaker the GBP will be.

Traders utilize multiple measures to analyse the strength or weakness of currencies relative to one another. The strong/weak analyzer for the Canadian dollar places it as the strongest currency on a list of 7. The weakest currency is the GBP at -7, followed by the EUR at -5, the USD at -3, the CHF at -1, the AUD at 1, the NZD at 3, the JPY at 5, and the CAD at 7. The latest GDP figures for Canada (2014) are $1.785 trillion, with a total population of just over 35.5 million people. While the country has dipped in terms of annual GDP growth between 2014 (2.4%) and 2015 (1.2%), increases are expected in 2016 (1.9%), 2017 (2.3%) and 2018 (2.4%). This is highlighted in the above chart. Canada’s exports of goods and services as a percentage of GDP measured 31.6% (2014). This figure has steadily been increasing since 2012 when it was last recorded at 30.2% in 2012, 30.2% in 2013 and 31.6% in 2014. Since the country’s top export is crude oil, the performance of crude oil on the global markets – WTI and Brent crude oil – impacts heavily on the strength of Canada’s currency.

Negative Interest Rates in Canada?

Canadian Metrics  

For starters, low oil prices mean that Canada receives less for oil that it exports, and with 3.1 million barrels of crude oil exports per day to United States, this translates into shooter losses for the currency. For example when the price of oil was $100 per barrel, Canada would effectively make $100 x 3.1M = $310M per day. Now that the price of crude oil is approximately $30 per barrel, Canada is generating $30 x 3.1M = $90.3M per day. And then there’s the issue of reduced economic growth around the world. Banks in Norway, Sweden and Japan have introduced negative interest rates which means that depositors are paying interest on money that they store in banks. Much the same is true across Europe with the European Central Bank too. If Canada decides to implement negative interest rates, that would further weaken the Canadian currency since it acts as a disincentive to foreign direct investment in the country, but at the same time it encourages long-term loans which is the whole point of quantitative easing in the first place. It is likely that the Federal Reserve Bank will hike interest rates in 2016 June, with scant attention on the global economy given that it is a domestic decision. This will likely have an impact on emerging market currencies, possibly even the Canadian dollar to a lesser degree.

That the Canadian dollar is valued at approximately $0.74 to the greenback is an important appreciation for the CAD. The strong rebound in the currency could indicate that the bear run on the Canadian dollar is over for the long-term, although short-term hiccups are likely to ensue. In January 2016, there were concerns among currency traders that the CAD may be valued at $0.59, but it has certainly dragged itself out of the hole and now sports a much improved exchange rate. While the CAD has gained approximately 8 percentage points since its lows in mid-January, it has a ways to climb towards parity yet. As always, the contributing factors to the strength or weakness of the currency pair are major economic announcements in the US, the price of commodities such as crude oil, and ongoing recessionary fears. Most everyone agrees that currency traders – although trading at lower volumes – are in for a highly volatile couple of weeks, perhaps months ahead. To this end, the general consensus is that the CAD will likely retreat over the short-term, but eventually finish 2016 in a much improved situation.

 

This article was written by Idan Levitov, Head analyst for anyoption.com