No Valentine for the Loonie from crude oil 12Feb16

No Valentine for the Loonie from crude oil

Michael O’Neill No

FX Consultant / IFXA Ltd


  • Retail Sales gives US dollar a boost
  • China data next week could raise risk aversion
  • Loonie and oil – not a love story

Sorry folks. There’s no "happy ever after" for the Canadian dollar and oil. Pic: iStock

By Michael O’Neill

WTI made a new 2016 low at 26.05 on Wednesday. USDCAD did not make a correspondingly new high for 2016-far from it. USDCAD remains over 0.0700 points below the level it reached on January 20 when oil first broke $27.00/barrel and traded at $26.85/b.

The relationship between USDCAD and WTI price movements may have cooled somewhat in the past 10 days but make no mistake, it is far from over. In January, USDCAD soared with oil’s relentless decline and peaked January 20 at 1.4688, coinciding with WTI touching $26.85/b. Since then, USDCAD has declined far faster and deeper than what appears warranted by WTI price moves.

It is debatable, but a large part of the USDCAD rally in January can be explained by the pessimistic expectations leading up to the Bank of Canada policy meeting on January 20. You will recall that China’s equity market crash at the beginning of the year spark risk aversion trading around the globe. The situation was made worse with sliding oil prices due to expectations of new Iran oil supply, rising storage constraints in the US and Opec’s unwillingness to cut production

While all that was happening, Canada was posting ugly economic data and the Bank of Canada (BoC) governor’s three prior speeches hinted that the BoC was considering cutting interest rates. By January 18th, the rate cut view was the majority view. USDCAD blew through key resistance in the 1.4000-20 area and then accelerated through 1.4440 like a Honda Civic on nitrous oxide.
When the rate cut didn’t happen, USDCAD reversed course.

Interestingly, it has taken just as many days for the Loonie to recoup its January losses as it took to make them. That is probably useless trivia but does speak to the diminished impact of low oil prices on the Canadian dollar.

The damage is still being done

The Saudi Arabian mission to crush high cost competitors has been a resounding success at least from Canada’s perspective. The Canadian oil patch is bleeding red ink into the black pools of Canadian crude. The damage to the Alberta economy due to massive lay-offs, housing price declines, and oil revenues is just part of the story.

The Canadian banks have large exposures to domestic oil companies in the form of loans while investors are watching energy stock prices collapse. Companies are facing additional woes. Oil hedges put in place to protect producers from falling prices are expiring. The Financial Post reported yesterday that nine small to mid-sized producers had 19% of their crude hedged at $58.00/b and those hedges are expiring this year. In 2017, those companies have hedges on only 3%. A TD bank report argues that Canada’s Oilsands producers need $40.00/b to break even so at current prices these companies are bleeding cash.

Oil matters but global sentiment matters more

Oil will still be a main driver of USDCAD direction but for the next little while intraday oil price swings may have a diminished impact on USDCAD trading. The February shift by global markets to a heightened sense or risk aversion has aligned USDCAD with overall US dollar direction. And US dollar direction is being driven by interest rate spreads, diminished expectations of US tightening and risk on/risk off trading with China as a major catalyst. China unloads a lot of data next week which may add fuel to risk averse sentiment.

Recently, USDCAD couldn’t break above 1.4000 even when WTI punches below 2016 lows but at the same time it can’t get below 1.3740 either. However, the topside cap is far more vulnerable than the bottom.

There is a lot of Canadian data next week including Retail Sales and CPI on Friday. If it is weaker than expected, it should maintain the topside pressure on USDCAD. The long term technicals are bullish as well. USDCAD is in an uptrend from May 2015 and that line doesn’t even get tested until the 1.3680-1.3710 area.

Heightened risk aversion, stable oil price and stronger than expected US data will make USDCAD a better buy on dips than a sell on strength, at least for the next week.

Chart: USDCAD daily with long-term uptrend

Source: Saxo Bank

The week ahead

China returns from holidays on Monday and the US and most of Canada take that day off. Monday, the European Central Bank’s Mario Draghi gives a speech and perhaps he can do what the Fed’s Janet Yellen couldn’t; provide some calm to the markets.

Tuesday will be sterling’s turn to shine and to see if economic data can take the focus off Brexit concerns.

Wednesday, the Federal Open Market Committee minutes will be studied to see if Yellen’s Humphrey Hawkins testimony bears any relationship to the monetary policy discussion on January 27. Thursday, Australia and China data will be the focus.

It is not a great week for data in the early part of the week but it finishes on a high note on Friday with US CPI .

The week that was

The past week had more than enough reasons for FX and equity markets to be quiet, dull and range-bound led by Chinese New Year, a holiday in New Zealand on Monday and a holiday in Japan on Thursday. That wasn’t the case.

The Monday Asia session lived up expectations and was deathly dull. It was a lot different in Europe. USDJPY started to slide (a trend that lasted until Friday), EURUSD rallied than dropped and GBPUSD just dropped. The sterling slide was on “Brexit” concerns and yen was bought due to risk aversion sentiment, in part due to a Wall Street Journal article on rising Investment Grade credit spreads. New York took the risk aversion ball from Europe and ran with it. US equities dropped, WTI oil broke below $30.00/b and gold caught a bid. FX volumes were high and liquidity was poor.

Tuesday’s Asia session picked up where New York left off. USDJPY continued to drop sparking a bit of verbal intervention from the Japanese Finance Minister which helped shore up the 114.00-20 floor, a level not seen since November 2014. EURUSD rallied in early New York trading but the move stalled at 1.1330. The Swiss France was the big winner by the end of the session and the US dollar ended the day down against all the G-10 currencies except for AUDUSD.

Wednesday, expectations of a quiet Asia session ahead of Janet Yellen’s testimony were dashed early on. USDJPY spiked higher on a bogus intervention rumour and then reversed itself just as quickly. Aussie and Kiwi slid initially but rallied into the Europe opening. Traders started being cautious in Europe ahead of Yellen and ignored domestic data. Yellen came across concerned about risks to the US economy and helped drive EURUSD higher by the end of the day. The big mover was USDJPY which crushed key support at 114.00-20 and never looked back.

Thursday brought an added measure of poor liquidity. Japan was closed but that didn’t stop traders from selling USDJPY which sank to 111.89 from 113.35. AUDUSD and NZDUSD both dropped on falling commodity prices. In Europe the Swiss National Bank president said that the SNB would be willing to intervene in FX markets which supported USDCHF. Janet Yellen’s second day of testimony delivered the same sort of remarks as the day before and naturally the result was the same. The US dollar finished the day down across the board except against GBPUSD and NOKUSD. “Brexit” worries undermined cable and falling oil hit the Norwegian krone. WTI made another new low, this time $26.05 but surprisingly the Canadian dollar held in very well, finishing flat on the day.

By Friday, the US dollar higher was higher on the day but mixed for the week with safe haven currencies gaining and the rest declining.

– Edited by Clare MacCarthy

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Categories FX, Foreign Exchange, Currency, Canadian Dollar

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