Negative oil outlook will weigh on Loonie 30Dec15

Negative oil outlook will weigh on Loonie

Michael O’Neill

FX Consultant / IFXA Ltd


  • Canadian dollar weakest of the majors
  • Oil prices remain on the defensive
  • Beware a BoC rate cut (really!)

Canada and Norway: Spectacular scenery, poor currencies. Pic: iStock

By Michael O’Neill

The Canadian dollar is ending the year on an erratic note with intraday oil price movements leading to wild swings. In addition, the prospect of Canadian dollar selling due to year-end demand has renewed the focus on 1.4000.

And the winner is….

The Canadian dollar has won the distinction as the “worst performing” G10 currency in 2015, shedding 18.00% versus the US dollar. At least, as of this writing. Its second closest competitor is the Norwegian krone. And the common denominator to both is the price of oil.

Chart: USDCAD, USDNOK, OIL US continuous 1 year

Source: Saxo Bank

Are oil prices pumped for a rally?

In November, 2014, the Organisation of Petroleum Exporting Countries decided that defending market share took precedence over defending oil prices and oil prices collapsed.
The following December, the US Energy Information Administration predicted that in 2015, the average price for WTI would be $63.00/barrel. The actual average is $49.08/b.

The EIA prediction for 2016 is that WTI will average $50.89.

That forecast implies a pretty good rally for WTI which is currently trading at $36.79/b. The EIA admits that there is a lot of risk to its forecast. Those risks note that Russia is producing crude in record volumes, Iran is getting ready to ramp up exports when the sanctions are removed, which may be as early as the end of January 2016 and US shale production has not declined significantly. The EIA also acknowledges that the prospect of additional weak economic growth in China and emerging markets will weigh on prices in a high production environment.

A Bloomberg story suggests that Saudi Arabia’s latest budget assumes Brent at $37.00/b. That price is seen as evidence that the kingdom will continue to defend market share and not cut production. The Iran oil minister says that Iran is budgeting using an average price of $40.00/b.

Chart: WTI price projections

Source: EIA

Forecasts show pain trade is down

The WTI price negatives are well-known but according to the EIA Short-Term Energy Outlook, traders appear more optimistic for prices to increase rather than decline. If so, a move lower will be more painful than a move higher.

The following EIA chart shows probability values calculated using NYMEX market data for the five trading days ended December 3.

Chart: Oil price probabilities

Source: EIA

A rate cut in Canada – surely you jest!

There isn’t a whole lot of bank economists forecasting a Bank of Canada rate cut in 2016. In fact, four of the biggest domestic banks, BNS, RBC, BMO and CIBC, expect Canadian rates to remain unchanged during 2016.

Those forecasts may change. Last week’s disappointing Canadian GDP data was weaker than expected, exacerbated by the third consecutive month of soft manufacturing shipments and puts a downside risk on many Q4 forecasts. Further weakness in oil prices should already be making the Bank of Canada nervous. The January 8 employment report may be the tipping point. The forecast is for a loss of 5,000 jobs in December, on top of the 35,700 job losses announced in November.

BoC governor, Stephen Poloz, gave a speech on December 8 entitled "Framework for conducting Monetary Policy at Low Interest Rates". It may have been due to the time of the year, but his remarks did not attract the attention that they deserved. That may have been a mistake.

On December 8 WTI prices were in the $37.50-$38.00/b range, October GDP was forecast to rise 0.3% CPI was expected to rise1.5%, y/y and October Retail Sales was expected to gain 0.4%. Oil prices have remained steady but everything else missed the mark. The possibility that the Bank of Canada surprises markets with a rate cut on January 20 cannot be ignored.

USDCAD uptrend is your friend

USDCAD has traded erratically within the a 1.3770-1.3990 band for the past two weeks and tested both sides of that range. The uptrend from the beginning of December remains intact while trading above 1.3830 suggesting further gains to 1.4055 and then 1.4285. A move below 1.3830 would lead to further weakness to 1.3670.

Chart: USDCAD daily

Saxo Bank

The last word for 2015

USDCAD appears poised to rally and test the Canadian 70 cent level or 1.4285 due to poor domestic data and the risk of even lower oil prices. The problem is that the current level of USDCAD, 1.3900, reflects all those concerns. Jokers are wild and in this deck, the joker is the Bank of Canada. Rate cut speculation is still a fringe idea. It may go mainstream with a poor employment report but until then, oil price movements will dictate direction.

Tomorrow’s month end and year end portfolio rebalancing flows are rumoured to require USDCAD buying. If so, the lack of liquidity could see USDCAD touch 1.4000 tomorrow.

– Edited by Clare MacCarthy

Categories FX, Foreign Exchange, Currency, Canadian Dollar

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