Canadian Dollar Under Pressure from Surging Delta Variant, Sinking Crude Prices

Canadian Dollar Under Pressure from Surging Delta Variant, Sinking Crude Prices

 Published: July 30th, 2021

While the global economy has climbed back from the pandemic in the first half of 2021, gains could stall as the new delta variant spreads worldwide.

The impact is already being felt in Canadian dollar markets, where the loonie lost nearly 2 per cent this week, dropping to almost 78 cents and wiping out its year-to-date gains. By week' end, there was a climb back to above 79.4, but analysts say downside risks could keep the pressure on.

An investor note from BMO Capital Markets in Toronto said the broader impact of the widespread rise in new ‘delta’ covid infections ‘hammers home the point that the pandemic is still with us, and isn’t going away any time soon.’ Recovery in areas like international travel, usually a reliable indicator of business activity levels, will be slow and extended, the bank says.

Canadian stock markets also felt the heat from the health crisis last week before recovering. Across the border in the US, Canada’s largest trading partner, state and local governments have so far reacted mildly to the delta variant’s rise, believing the adverse risks to the economy outweigh the potential health risks.

But the prospects of a COVID-19 ‘fourth wave’ could trigger change, especially if the Federal Reserve changes course following its meeting next week. Doves on the Fed’s policy committee might see the delta risk as a reason to continue its easy policy on interest rates. However, analysts at Oxford Economics told Bloomberg that America’s robust growth so far this year and corresponding inflation pressures 'could push the majority into a less dovish frame of mind.'

Canadian health officials are worried about delta

Health officials in Ottawa have expressed concern about the virulence of the delta strain. Close to 80 per cent of people in Ontario, Canada’s largest province, have had at least one dose of a vaccine. But the province’s chief medical officer wants to see a 90 per cent vaccination rate to minimise the impact of the new highly transmissible COVID variant.

In the province of Quebec, the government has launched a new lottery worth CDN 2 million in cash prizes and university grants, saying the delta variant is behind the new fundraising venture.

The renewed focus on COVID as an economic worry will likely continue to impact the loonie, which has been inching closer to the USD 80-cent level, seen by markets as the level that indicates healthy synchronicity between the Canadian and US economies.

In the near term, price movements in CDN will likely be tied to shifts in risk sentiment, said analysts at TD’s currency strategy unit. ‘If markets start to believe that the delta variant won’t disrupt global growth, a rise in risk sentiment would simply establish a floor under the loonie with room left for modest upside.’

Oil prices make their impact felt

Alberta oil markets were also heading for their first dip in over a week as investors took in the demand outlook amid a return to COVID-19 worries and as global markets looked to be on a weaker footing.

‘Concerns about the surging delta variant will persist for some time yet,’ said analysts at Calgary’s PVM Oil in comments to the National Post newspaper. The oil market is expected to stay in deficit, they noted, which should maintain a floor under crude prices.

Analysts at Scotiabank were more upbeat about economic growth prospects in both Canada and the US.

‘Our forecast is based on the Bank of Canada lifting interest rates in July of next year, and the recent moves to taper down asset purchases suggests things are moving in that direction.’

Over at BMO, however, forecasters are walking back 2021 growth predictions somewhat for the US, which are always felt directly in Canada’s economy.

‘Upside growth risks have been capped, but downside risks are rising again thanks to the recent series of negative events related to the ongoing pandemic. The concern is that delta could herald a new set of commercial restrictions that hamper growth.' Those concerns, however, would only affect the near-term outlook, they said, and simply push back some of the expected rebound into 2022.

Another view

Despite the delta worries and the potential for another oil price slump, the commodity-dependent Canadian dollar has been one of the best-performing majors of 2021. Analysts at Deutsche think it may be poised for a second wind.

The bank's forex strategy unit published an analysis this week that said 'despite the recovery being dragged down by the delta variant, Canada’s ties to the global economy mean that, in aggregate, economic growth should remain robust.’

That’s down to Canadian currency market fundamentals such as stable or rising prices for raw materials like wood, iron, and oil, plus supportive policies from the Bank of Canada. Taken together, they've shored up the reflation trade this year, even as some traders have pulled back from CAD.

When the loonie has suffered setbacks this month, Deutsche says it’s because asset managers had scaled back long reflation bets when worries about delta cases began to intensify.

In options markets, investors have been more likely to hedge risks around short-term events. CAD volatility curve is inverted at the moment, suggesting overall confidence in the belief that calm and growth will overcome near term market jitters. For forex traders betting on reflation, CAD could turn out to be a key part of their trading toolkit.

In line with that approach, Deutsche is suggesting a basket of currencies including CAD, NZD, and NOK for long bets against the yen.

Commodity prices, meanwhile, bounced back from sharp setbacks over July to hit fresh six-year highs this week. That’s good news for the Canadian dollar and other resource-linked currencies, pointing to a return soon to the long-term upside trend.

Show Results