Oil Price Uptrend Set to Pull the Canadian Dollar Higher

Oil Price Uptrend Set to Pull the Canadian Dollar Higher

Published: February 12th, 2021

Crude markets are heading upward, and that’s good news for the loonie and other oil-linked currencies. Analysts see little on the horizon that will halt oil’s appreciation — at least until Brent Crude reaches the USD 70 per barrel level.

Brent’s price and oil’s other global benchmarks have been on the rise since April of last year when investors started to look past the coronavirus pandemic and see signs of economic recovery. That raised the foreign exchange earnings potential for major oil-exporting economies like Canada’s.

Though the August-November period last year saw a small oil price dip, the broader trend has returned with gusto this year, and currency markets have been buoyant in response.

Securities researchers at MUFG told Bloomberg this week that oil price developments are behind the firm’s bullish outlook for oil-linked currencies over the rest of 2021.

In recent months, oil-related currencies' performance has become inexorably linked with oil prices, they said. Price rises for the specific type of oil Canada produces have been notably sharp, rising more rapidly than the global Brent and West Texas Intermediate (WTI) benchmarks. Canada’s own crude benchmark, Western Canada Select, has been on a tear, lifting to the price levels last seen in September 2019.

That’s making the canuck dollar more competitive against other majors. The pound-to-loonie exchange rate had risen from a low of 1.6768 in December to a height of 1.7640 at the end of January, but sterling’s rise has stalled, and the pair has fallen back to 1.7526.

Oil prices keep CAD competitive against other majors

Analysts say that the oil price trend will likely continue to impact on the Canadian dollar outlook. MUFG expects oil prices will continue going up in the coming months, a prediction that’s prompting bullish pronouncements on the loonie’s near-term prospects.

The velocity of the oil price uptrend since the turn of the year has analysts cautiously suggesting Brent will hit USD 70 per barrel this year. Rising demand levels support further price rises.

Given the rally in the oil prices, Western Union’s UK currency strategy unit is advising clients to watch oil-linked currencies closely for trading opportunities.

Oil prices were on the move last week and continue to be elevated. Western Union told investors this week that some of the price lift is likely down to OPEC comments about plans to cut supply. An improving economic outlook and expectations of additional economic stimulus from the US Fed are also giving crude demand a boost, and oil-backed currencies will likely benefit.

Commodity-correlated currencies like AUD, NZD, ZAR should be watched closely, especially the big oil exporters like NOK, RUB and CAD.

OPEC moves to keep crude prices on the up

In early January Saudi Arabia said it would scale back production by an additional 1 million barrels a day between February and March. That’s despite Russian plans to boost output. The Saudi move is seen as an attempt to keep the OPEC+ group’s tetchy alliance intact against the drops in demand seen during parts of the coronavirus pandemic.

Last week Saudi Arabia went against market expectations of a 14 per cent cut to output, sticking with its USD 1 premium pricing for Arab Light crude.

With the Kingdom has committed itself to additional supply cuts in the second quarter, it’s unlikely oil prices will fall further any time soon. That will keep commodity currencies like the loonie trending higher.

The Norwegian Krone is another oil-linked currency to keep an eye on. Krone has bounced back strongly this week, also in tandem with rising oil prices, and putting majors like the pound under pressure.

Rallying oil prices had GBP/NOK on the defensive this week, and could serve as a warning for a potential dip in GBP/CAD should oil prices keep climbing.

Commodity analysts at OCBC in Singapore said in a research note this week that the crude oil ‘locomotive’ won’t stop chugging anytime soon. The bank expects oil price appreciation to extend, and that the bank is going tactically long Brent crude prices.

The note went on to say that Brent is unlikely to slow down until it crosses the USD 60 per barrel mark. The upward trend will continue, they say, because it's supported by demand indicators and the Saudis’ moves to tactically stem supply.

In addition to Saudi Arabia's announcement, crude oil inventories in America continue to drop while crack margins in Asia continue to climb.

Living up to expectations

Back in December, a poll of more than 40 forex strategists suggested the Canuck dollar could strengthen by more than half a percentage point in the first quarter of 2021. After that, predictions were that the loonie could climb to 1.30 over the remaining three quarters.

Oil was a big part of that calculation. One of the respondents, BMO Capital Markets in New York, told investors that the firm expected oil and other commodity prices to bounce back in the second half of 2021. That prediction has come true much earlier than expected and could be part of a broader commodity price bump with the potential to push the loonie up and up.

Oil is one of Canada’s major exports. When crude prices cratered by close to 40 per cent in the early part of 2020 due to dramatically slowed global economic activity caused by the coronavirus pandemic and government lockdown measures, some predictions had traders acting on caution where CAD was concerned.

In response, Ottawa moved to keep interest rates at record lows while keeping government spending at record highs. Analysts say that the simple two-pronged strategy has helped keep the economy afloat.

Real estate bubbles in Toronto and Vancouver kept home prices rising sharply last year. Economists at the Bank of Canada (BoC) said lower immigration and higher unemployment would likely cool demand. Still, it remains to be seen if that will hold against rising oil prices.

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