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Canadian Dollar to be Wagged by its Oil Price Tail Before Long Say Strategists

How long will the Canadian Dollar ignore its old friend, the price of oil, particularly if crude prices continues to surge over coming weeks?

Oil could soon begin to reassert its influence over currencies like the Canadian Dollar and Norwegian Krone, according to strategists, particularly if prices continue their nascent surge.

Tuesday saw West Texas Intermediate crude futures trade at $57.69, their highest level since July 2015, as traders bet that Saudi Arabia will make good on its pledge to support an extension of the OPEC oil agreement on supply growth this November.

However, the Canadian Dollar has gained less than 1% on a trade-weighted basis during the November month-date, while WTI is sat on near-5% gain for the week-to-date and has risen 15% during the last month. Similar is true of the Norwegian Krone.

Traditionally, the value of oil has played a big part in determing the overall value, and day-to-day moves, in the CAD and NOK as oil exports constitute a major portion of their export basket of Canada and Norway.

However analysts have noted that both currencies have opted to sit out the latest surge in crude oil prices.

West Texas Intermediate crude futures shown at weekly intervals. Source: Netdania Markets.

“The truth is that the CAD and NOK's close relationship with oil has been less assured for some time, due largely to the greater prominence of yield enhancement as a driving force in the currency markets,” says Neil Mellor, chief currency strategist at BNY Mellon.

This could be a sign that traders are sceptical of about oil’s ability to sustain its recent gains. But it could also be down to other factors.

After all, divergence between Canada’s Dollar and the price of crude comes at a time when markets are mid-way through repricing a series of changes to the interest rate outlook at home and abroad.

“What is striking is how little impact this Oil move is having on other markets. In Rates, we have seen no significant move higher in Inflation Breakevens and Bond yields, and for FX, CAD and NOK have hardly moved,” says Ray Farris, a foreign exchange strategist at Credit Suisse.

Still-low inflation and signs of a looming economic slowdown emerging in Autumn’s economic data saw the Bank of Canada turn cautious, after pushing through two back-to-back interest rate hikes between July and September. This saw traders begin unwinding record bets on a additional interest rate hikes and further gains for the Loonie.

“Given we favour further Oil strength, we feel these disconnects can have a material impact if they start to close,” Farris adds.

Bond and interest rate derivatives prices still imply some chance that the BoC will hike rates in December yet most economists agree there is very little prospect of this happening. That said, small implied probabilities can drop out of the market at short notice.

“We would caution against any presumption that the breakdown in the close relationships with oil will endure, and certainly if oil prices continue in the same vein,” says Mellor at BNY Mellon.

USD/CAD rate shown at 4 hour intervals.

A number of strategists see bets against the USD/CAD rate as the best way to play resurgent oil prices in the foreign exchange market. This is as much the result of what many say are unrealistic expectations around President Donald Trump’s tax reforms as it is the recent sell off in the Canadian Dollar.

“For USDCAD though, strength has extended to test and be capped at what we see as key resistance, starting at the 50% retracement of the May/September fall at 1.2927 and stretching up to the 200-day average at 1.2999,” says Farris.

Farris notes a technical “sell signal” on the USD/CAD charts that indicates, to the Credit Suisse team, a move lower to the 1.2598 level is likely in the short term.

“And if CAD were to catch-up to the Oil rally, we would expect a move below 1.2585 in due course to target the 55-day average and 50% retracement at 1.2489/88,” the strategist adds.

Farris isn’t the only strategist eyeing a possible fall in USD/CAD over the coming days as analysts at TD Securities recommended that traders sell the rate short this Monday.

“We note that while the beta has declined significantly since the peak during the commodity super cycle the recent bump in oil could reinvigorate some of the old links between two asset classes,” says Mark McCormick, a North American strategist at TD.

TD Securities have advocated entering a short trade around the 1.2770 level and placing a stop loss at 1.2960, to target a move lower down to the 1.2380 threshold.

USD/CAD rate shown at daily intervals.

McCormick cites recent changes in Canadian Dollar positioning and alludes to a mismatch between market expectations for BoC rate hikes and TD’s own forecasts as supporting the trade recommendation. 

“The magnitude of the correction has dovetailed with the shift in the BoC narrative and the soft patch in data,” the strategist notes. “Even so, we think much of the bad news is priced in and remain of the view that the BoC will hike again early next year.”

The USD/CAD rate was quoted 0.22% lower at 1.2734 shortly ahead of the London close Wednesday. The Pound-to-Canadian-Dollar rate was down 0.76% at 1.6680.

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