Canadian Dollar Forecast to Retain Weak Bias on BoC Policy and Oil Price Declines

- CAD outlook soft says MUFG
- BoC could expand quantitative easing
- Oil prices provide additional headwind

CAD poloz

Above: File image of BoC Governor Poloz. Image © Bank of Canada

- GBP/CAD spot rate at time of writing: 1.7601
- Bank transfer rates (indicative): 1.6985-1.7108
- FX specialist rates (indicative): 1.7205-1.7443 >> more information

The Canadian Dollar is expected to maintain a soft tone against the Dollar, Pound and other currencies amidst an environment of subdued oil prices and an increasingly more proactive Bank of Canada (BoC).

The BoC trigged a shift lower in the value of the Canadian currency mid-week after it announced it was to expand its maiden quantitative easing programme and set out plans to buy up to 40% of treasury bills sold at auction in what could amount to partial 'monetisation' of the budget deficit.

The BoC will now include as much as C$50BN in provincial bonds and C$10BN in high grade corporate bonds in its quantitative easing programme in addition to the C$5BN in federal government bonds it intends to purchase every week.

The move to support asset prices - and by extension the economy - via what is effectively a money printing programme came after the BoC opted to leave its basic interest rate unchanged at its new record low of 0.25%, which is down from 1.75% in January.

Recognising that it is futile to cut interest rates beyond 0.25% the BoC is exploring more exotic methods of supporting the economy but standard foreign currency theory says that when a central bank slashes interest rates and prints money via quantitative easing, the currency it issues falls.

"The Canadian Dollar weakened sharply yesterday as it was hit by double whammy from lower oil prices and further BoC monetary easing. It helped to lift USD/CAD back above the 1.4100-level," says Lee Hardman, Currency Analyst at MUFG. "The BoC did though signal that they stand ready to augment the scale of any of its programs should market conditions warrant it."

However, with the majority of central banks engaged in the same activities, we would expect the impact of the BoC's decisions to be less severe on the Canadian Dollar.

The U.S.-Canadian Dollar exchange rate is seen trading at 1.4097 as a two week period of depreciation in the Dollar reversed sharply on the BoC decision.

The Pound-to-Canadian Dollar exchange rate rose to a high of 1.7695 in the wake of the decision, but has since retraced some of those gains. We note the general trend in GBP/CAD to be higher, although we note the GBP and CAD appear to be relatively evenly matched ensuring progress in either direction tends to be slow.

What we can say with confidence regarding the outlook is that the Canadian Dollar can no longer look to its central bank for support, after all BoC rates were some of the highest amongst developed economies at the start of the year, a situation that ensured the Canadian Dollar found a solid bid from incoming foreign investor capital that sought to take advantage of the higher returns offered in Canada.

In short, this should ensure any upside in the currency will likely remain capped.

"The scale of the negative economic shock hitting Canada’s economy will keep the BoC under pressure to deliver further support measures," says Halpenny. "In these circumstances, we maintain our bearish outlook for the Canadian dollar in the near-term,"

MUFG forecast USD/CAD is likely to rise back towards the 1.4500-level.

Recent losses in the Canadian Dollar do also appear to be closely tied to a return of investor nerves concerning the global economic outlook over the course of the past 48 hours.

The continued fragility in global oil prices is meanwhile also seen to be a driver of Canadian Dollar underperformance as lower oil prices tend to diminish Canada's foreign exchange earning potential.

Oil prices are falling once more as the overwhelming drop in demand from a shuttered global economy continue to exert a toll, confirming that the supply cuts promised by OPEC+ over the weekend are simply too little to bring equilibrium to the market.

"The current consensus is that because central banks are flooding the market with liquidity, much of it will push asset prices up and the low-yielding USD down. Apocalyptic economic assessments, even from the IMF, have been shrugged at, but one thing that market participants can't ignore is oil prices – they appear to be headed off a cliff again," says Ewen Chew, an analyst at Thomson Reuters.

Oil demand is predicted to fall by a whopping 29 million barrels per day in April alone, according to then latest IEA data.

"Whether today’s slump in oil prices serves to rally OPEC+ into another cut remains to be seen. However, with the group having difficulty achieving the 9.7 million barrels per day cut, an inability to enact further restrictions would likely lead to further downside for the months ahead," says Joshua Mahony, Senior Market Analyst at IG.

Over the weekend OPEC and Russia agree to cut production by 9.7 million barrels per day over the course of the next two months, which represents the largest margin ever agreed by OPEC.

But it is estimated that global demand has fallen in excess of 30 million barrels per day in the second quarter as the world's largest economies shut down to try and stem the spread of the coronavirus.

The OPEC+ deal remains in place until April 2022, with the quotas increasing by 2 million barrels per day in the second half of 2020, and then another 2 million barrels per day up to April 2022.

The reference point for the cuts was production in October 2018 for most, although both Russia and Saudi agreed to a baseline of 11 million barrels per day.

A significant problem facing oil producers is that simply cutting supply is not as easy as simply turning off a tap as most oil fields and supply lines are designed to keep pumping, which draws question marks on how achievable the agreements inked on paper really are.

For example, while Russia has committed to a 2.5 million barrel per day cut, analysts suggest this is more than 10x its agreed cut under the last OPEC+ deal.

"The demand drop for oil as countries have locked down activity has been unprecedented, with demand in April expected to be down more than 20mb/d. Huge uncertainty remains about the duration of the lockdowns and hence the timing of a demand recovery. In April alone, global inventories could grow by 600m barrels; if there is not a sharp improvement in demand in May then global storage infrastructure risks being overwhelmed, even with the OPEC+ cut," says Henry Tarr, Analyst at Berenberg Bank.