Published: May 1st, 2020
The Canadian dollar stood strangely firm last week – in the midst of a historic plunge that saw crude oil futures go negative for the first time ever.
While other oil-dependent economies nosedived – the Norwegian Krone dropped more than 3 per cent while the Mexican peso plunged 5.6 per cent – the Loonie held its value, sliding a mere 0.7 per cent against the US dollar.
That relative stability was in sharp contrast to the full 7 per cent drop in West Texas Intermediate that happened in the same week – a clawback from losses that plumbed depths of -$40 a barrel at Monday’s opening.
Crude oil and the Canadian currency had been in-sync for most of the year. But then the COVID-19 pandemic brought the global economy to a screeching halt, smashing demand for crude just as an oil-price war was hotting-up between OPEC and Russia.
Since then the oil-loonie link has become more tenuous. It unravelled further last week as markets offloaded front-month oil futures contracts on reports of a storage capacity crunch exacerbated by the global glut.
Market watchers have different takes on why the connection between oil and the Canadian dollar might have broken down. Some believe investors had already priced-in the impact of slumping demand combined with oversupply.
Others said the country’s high consumer debt levels and the threat of a crash in tight urban property markets like Vancouver and Toronto could hurt the economy and thereby the currency – prompting a further weakening of the relationship.
Forex analysts at Canada’s Bank of Nova Scotia have suggested the Canuck dollar’s performance might be influenced more by the pandemic’s economic fallout than the price of oil futures. Traders had likely priced-in the mix of oil over-supply and demand shortfall before prices plunged, preparing for a short-sharp drop in crude’s pricing.
In unprecedented times, currency markets were looking across all contracts and grades for signals, rather than staying unduly focused on benchmark indicators like front-month WTI.
All eyes are now on Canada’s upstream oil producers, likely to be among the worst-hit by over-supply issues, thanks to pipeline bottlenecks which are stopping more Canadian crude from getting to American refineries.
Analysts at Bay Street bank CIBC believe forex markets are looking to longer-term oil futures’ contract dates with an expectation that demand will eventually bounce back. When that happens, they say, the correlation between oil futures and the Loonie's performance will tighten again.
FX traders believe that the demand shock will be short-lived, and front-month contract pricing under pandemic conditions doesn’t reflect the crude market’s real fundamentals.
The Loonie's lack of volatility relative to its sister petrocurrencies and broader crude markets adds credence to the idea that short-term moves in crude at extreme price levels won’t have lasting economic implications.
Plummeting prices for Western Canada crude means Canadian upstream oil companies will be loss-making for the foreseeable future. With the country’s energy sector in disarray, the Canadian dollar will be relatively immune to sudden to’s and fro’s in the oil market.
Over the longer-term, oil’s difficulties could create structural problems for Canada’s economy, affecting its trade and current account deficits. Canadian households are racking up high levels of debt at the same time, while housing markets look vulnerable to a crash if joblessness and the overall economic outlook worsens.
In the US meanwhile, the Federal Reserve is driving the global monetary policy response to COVID-19 by aggressively buying bonds and corporate credit while cutting interest rates to zero. Its ongoing bailout program was extended this week to include purchases of municipal debt from smaller USUS cities which are feeling the first effects of economic slowdown.
Analysts believe further major policy moves from the Fed are unlikely, given the depth and scope of its recent actions to counter economic damage. That will also affect currency policy at Canada’s central bank, and further afield.
In a recent market commentary, Commerzbank’s currency unit said that central banks are all in expansionary mode and have ramped-up asset purchases as much as possible. Almost all have hit their minimum lower interest rate bound and will have to stay there for the foreseeable future. That should have a stabilising effect on exchange rates.
With less room to manoeuvre on rates, the European Central Bank (ECB) has announced a massive programme of bond purchases. But North-South disagreements within the eurozone over a comprehensive rescue package has some analysts predicting stronger action in the coming days.
Traders may decide to leave the euro behind if expectations for economic re-start in the USUS pressurises the greenback and drives further rallies in riskier currencies like the Australian dollar.
The Aussie’s own link to oil prices has been sustained by the clawback in future contracts pricing, helping it recover at points this week from a 17-year low struck last month.
Elsewhere the pound has shown signs of strength on renewed calls for the UK to relax its strict lockdown and slowly return the British economy to ‘normal.’
Going into May market watchers were pointing to a broadly positive outlook for the Canadian dollar on forex markets after close to a month of general appreciation. The Loonie looked to be joining other petrocurrencies at the end of April in its response to an uptick in positive risk sentiment.
Over the course of April trading, the Loonie appreciated by 2 per cent against the greenback, 1.7 per cent against the euro and 1.3 per cent against sterling.
Some analysts say question marks remain, however, over the Canuck currency’s ability to sustain that appreciation. Markets want more clarity on the shape of international economic normalisation how quickly nations can re-start and resume something like normal commercial activity.
Analysis by TDTD Securities FXFX Strategy unit points to the Loonie being potentially overvalued on some metrics. ‘Oil currencies are beginning to look stretched in our view, increasing vulnerabilities for the likes of CAD’.