Published: April 5th, 2023
The Loonie got a shot in the arm this week as oil prices rose by more than 8 per cent in the wake of a surprise production cut pledge by the OPEC+ group.
Markets were blindsided by a weekend announcement from the crude cartel that saw members agree to slash nearly 1.7 million barrels of oil per day from May 2023 through to December. The Saudis have agreed to the most extensive cuts, scaling back production by 500,000 barrels per day.
An analysis by Bloomberg says the move should give support to petro-currencies like CAD. While the cuts will tighten crude supply, the world economy should see a fresh inflationary jolt as a side effect.
Central banks will have to act, meaning more rate increases than markets had priced-in before the OPEC+ bombshell. At time of writing, USD/CAD was close to dipping below a bullish trend line after reaching some key support levels.
Alongside the Saudis, Russia extended a previously announced cut of 500,000 barrels per day through to year-end. Several other Gulf states also joined the group policy and announced their own cuts.
A production cut of nearly 1.7 million barrels of oil per day is significant, Bloomberg says, and should meet the cartel’s aim of keeping crude prices supported.
The USD/CAD rate has also been impacted by an improving risk appetite across financial markets. The US Federal Reserve had been signaling that rate increases might be paused, putting the Greenback on the back foot.
The core PCE Price Index, which is the Fed’s benchmark inflation gauge, came in weaker than expected on Friday 31st March. The OPEC+ announcement followed the next day and will likely compel Fed policymakers to re-think rate decisions.
Meanwhile this week could be a busy one for CAD bulls, with Canadian employment reports, private payrolls and ISM services PMI all due before week’s end.
As recently as December, analysts were saying the return of declining crude oil prices would pull the Canadian Dollar down in 2023.
Analysts at Bank of Montreal (BMO) said a (then) recent dip in oil prices looked like a long-term trend, and is contributing to the Loonie’s recent decline. They do say, however, that an oil price recovery is expected next year. That would give CAD some support.
‘The unexpected decline in oil prices over the past seven days has trickled through to forex markets in the ways we would expect,’ wrote BMO in a recent currency briefing. For the Canadian Dollar, that’s manifesting as underperformance linked to oil market dynamics. ‘The surprising shift in crude prices is hammering commodity currencies like CAD.’
The Loonie had been the biggest loser amongst the major commodity currencies over a 30-day period, though it wasn’t alone. The Norwegian Krone, Europe's top petrocurrency, was also on the back foot.
BMO said all these moves confirmed the oil linkage. ‘What we are seeing is a broad rally for oil importing currencies while oil exporter currencies suffer.’
BMO noted that the Pound to Loonie (GBP/CAD) exchange rate had risen for five weeks in a row, extending an appreciating trend that first emerged in September 2022.
Earlier in July 2022, analysts at Montreal-based Desjardins Bank were saying the Canadian Dollar was headed for steady declines.
In a mid-year currency market analysis, economists at the bank’s FX Strategy Unit said the global economic outlook would be challenging over the coming months, a backdrop which would work against the Commodity-sensitive Loonie. Rising interest rates from the Bank of Canada (BoC) were also expected to add headwinds by pressurizing Canadian households already laden with credit card debt.
‘Global recession worries are already impacting the Canadian dollar, which isn't normally seen as a safe haven during times of upheaval. Markets are still disrupted, and risk-appetite remains weak across the board, though there have been occasional spikes of optimism.’
Investors were also expecting Ottawa to lift interest rates by nearly 200 basis points over the next six months as policy makers looked to cap rising inflation and try to work in parallel with the US Federal Reserve.
‘Markets are looking for interest rate rises in Canada to be at the high end, though not high enough to nudge CAD’s value upward. Hiking interest rates could also aggravate Canada’s high levels of household debt and even cause a significant correction in the residential housing market.’
Desjardins called it partly right. As the second half of 2022 kicked off, the Loonie was the second-best performing currency of 2022 amongst G10 majors, trailing just behind the outperforming greenback.
Fortunes in the subsequent months were up and down, with gains driven by a blend of strong post-COVID economic growth, rising oil prices, and a strong demand from Canada’s biggest trading partner south of the 49th Parallel.
At the end of May CAD was headed toward the bottom of the G10 league table, having been outperformed by all but mighty USD. In fact, it started June just ahead of the Mexican Peso, which topped the G20 list.
Drifting CAD performance helped the Pound to Canadian Dollar exchange rate stay north of the 1.60 level for the most of this week’s session and might free the pair to recover ground lost recently if it can sustain that handle through the coming weeks.
In a research briefing at the time, RBC Capital Markets’ FX Strategy Unit said that the top cash rate had fallen by close to 20bps over consecutive sessions, and blamed ‘spillover’ from US market sentiment for the trend.
The impact was ‘symmetrical,’ RBC noted, as US trends can send Canadian cash rates higher or lower.
RBC also said that market expectations for the Bank of Canada’s (BoC) top cash rate dropped in late May in sympathy with their American equivalents.