Canadian Dollar Forecast to Remain Under Pressure

- CAD reels under impact of oil price slump
- Negative impact to be enduring warns Nomura
- BoC rate cuts to deny CAD another pillar of support

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Foreign exchange strategists at Nomura - the global investment bank - expect the Canadian Dollar to remain under pressure amidst an environment of suppressed oil prices.

"We think lower oil prices could persist, resulting in an enduring negative effect on Canada’s economy and capital flows," says Jordan Rochester, FX Strategist at Nomura.

The Canadian Dollar slumped by over 2.0% against the British Pound on Monday, March 09 after a precipitous fall in the price of crude oil followed a failure of OPEC+ to agree a fresh round of oil production restrictions in order to prop up prices.

The decline in the Canadian Dollar allowed the Pound-to-Canadian Dollar to push to fresh highs at 1.8053, before gains were pared back to the current 1.7730 level after meeting some notable technical resistance. The U.S.-Canadian Dollar exchange rate meanwhile touched a multi-month high of 1.3796 yesterday and further gains by the U.S. currency look likely.

The cost of both major crude benchmarks has now fallen to below $40 a barrel, it is believed that break-even for many global producers resides at around $60 a barrel.

Canada is the fourth largest producer and fourth largest exporter of oil in the world with 96% of Canada’s proven oil reserves being located in the oil sands of Alberta. Oil sands accounted for 64% of Canada’s oil production in 2018 or 2.9 million barrels per day, with the remainder coming from conventional extraction methods.

Economists do not believe the sudden drop in oil prices will lead to a large drop in production as there are relatively few new projects coming on line; it is these that tend to be most exposed to sharp drops in prices.

However, oil accounts for a little over 20% of Canada's total exports, making it a significant foreign exchange earner that props up the value of the Canadian Dollar. Higher oil prices and higher production volumes therefore naturally earn Canada more foreign income, prompting a stronger Canadian Dollar. Lower oil prices, as we have seen this week, flip the equation on its head.

"Oil exporters such as Canada and Norway are the usual contenders for reacting to moves in oil prices due to their respective terms-of-trade shocks," says Rochester.

Faced with the prospect of weakening economic fundamentals, the prospect of another interest rate cut at the Bank of Canada (BoC) is rising, a development that could further undermine CAD strength.

The BoC cut its cash rate for the first time since July 2015 on Thursday, March 05, taking it down from 1.75% to 1.25%. However, the rate remains one of the highest amongst developed markets and is therefore still a source of support to the Canadian Dollar. Global capital tends to flow where returns are higher, and with a return of 1.75%, Canada attracts capital.

However, cut that rate further and another pillar of support for the Canadian Dollar is lost. Indeed, Bank of Canada governor Stephen Poloz said on Friday, March 06 that further interest rate cuts were possible, if required.

"The pernicious combination of a notable fall in global demand via the COVID-19 outbreak and collapse in oil prices presents a key risk to oil-exporting nations such as Canada, leaving FX as a key stabilising mechanism, while the Bank of Canada (BoC) has little patience," says Rochester.

Courtesy of the sharp drop in the value of the Canadian Dollar over at the start of the week, the currency is now the worst performing in the G10 space:

According to Rochester, further losses are likely in the current environment of coronavirus fears and low oil prices.

"We expect market expectations to solidify around near-certain additional easing by the BoC. Overall, these developments only strengthen our view for medium-run depreciation pressures on CAD to persist," says Rochester.