A mid-October decline in crude oil prices produced a bleaker outlook for the immediate future of the Canadian dollar (CAD), which enabled the US dollar (USD) to get back on the front foot in the USD/CAD currency pair.
On October 15, crude oil prices shed over 3.5% of their value in a single day. The CAD is regarded as one of the world’s leading commodity currencies, such is the Canadian economy’s reliance on the money that it generates from exporting key goods.
Any decline in oil prices is liable to weaken the CAD, which thereby strengthens the USD’s position in comparison to the loonie. That was the case in March 2020, where oil prices plummeted to a four-year low and the USD/CAD rose to its highest level since May 2017.
Neither oil prices nor the USD/CAD currency pair behaved so dramatically in mid-October, but the general trends were the same. Experts have expressed their concerns about the future of oil prices in the coming months, so there may be more scope for the US dollar to make gains against its Canadian counterpart.
An otherwise strong year for CAD
While the USD’s position as a safe haven has proven reassuring to traders at several junctures throughout the year, the overarching narrative in 2020 for the USD/CAD currency pair is one of Canadian resilience.
USD/CAD rose by approximately 2% on June 12, with that single-day increase the consequence of the US Federal Reserve taking the investing community by surprise with its indication that interest rates would remain low for the next couple of years. That sent markets scrambling, with oil prices also falling to further weaken the CAD’s position.
Yet that was a fleeting moment of strength for the USD, with the CAD swiftly recovering its losses against the greenback. From June 12 to the start of September, the USD/CAD pair slumped by approximately 4.4%.
That saw its June mark of 1.3638 traded for prices in the region of 1.30 as September began. This is an indication of the strength of the CAD, as fewer Canadian dollars were required to purchase one US dollar.
That may not seem like a significant drop, given that the USD/EUR retracted by around 5.5% and the USD/GBP shrunk by around 5.9% in the same time period.
However, the USD/CAD currency pair is not one that is known for its volatility. This can be observed through the margin requirements put in place for forex brokers in Canada. Margin requirements contribute to Canada’s strict regulatory environment for currency trading. The margin requirement determines the percentage of their capital that a trader must put forward to open a new position on a market, with a higher margin percentage necessitating more funds upfront.
The reason that margin requirement is a good indication of a currency pair’s traditional volatility is that the pairs more prone to fluctuations have higher percentages. For example, the notoriously unpredictable pair of the South African rand and the Japanese yen (ZAR/JPY) usually comes with a margin requirement of around 29%, whereas the USD/CAD pair has a much more conservative 2% capital requirement for traders seeking to open up a position.
This makes the stretch between June and September for the USD/CAD currency pair particularly notable. The USD clawed back a small proportion of its losses in September, before almost retreating into the 1.31 region. The USD/CAD had not hovered around the 1.30/1.31 mark since January 2020, a testament to the CAD’s resurgence.
Oil concerns to dampen CAD optimism
The news of crude oil’s price decline gave the USD a platform to bounce back, with the USD/CAD ending October 16 at the 1.3225 level. Further gains are likely to be predicated on the long-term forecast for oil prices, with any bleak outlook for the commodity certain to be bad news for the Canadian dollar and the nation’s wider economy.
Other factors inevitably influence the USD/CAD currency pair, given the countries’ heavy trade links and geographical proximity. As demonstrated by that shift in momentum on June 12, the policies announced by either the Federal Reserve or the Bank of Canada can influence market sentiment.
General politics can also be significant. The last few months of 2020 for the USD/CAD are likely to be shaped by the outcome and immediate aftermath of the US presidential election, although this is not a phenomenon unique to the United States and the Canadian economy.
Markets all over the world will be affected by the victor’s presidential vision for the country, with their new social and fiscal policies having the potential to either instill confidence in the American economy or place the long-term future of the US dollar in jeopardy.
Given the US dollar’s prevalence all over the world, as a peg for some currencies and as the central part of dollarized economies, this promises to be an important close to the year. However, crude oil prices may still prove to be the dominant factor in shaping the USD/CAD currency pair.
The International Energy Agency’s October report is grim reading for commodity currencies. The IEA calls the outlook ‘fragile’, raising serious concerns about the long-term prospects for growth in oil demand. The IEA anticipates a stock draw of 4 million barrels per day in the fourth quarter of the year, although this statistic should be caveated with the acknowledgement that these figures are coming off the back of record-high levels.
Yet the IEA ends its October report with the declaration that oil producers have little cause for optimism in the long term. At the start of 2020, some experts were predicting that oil prices would not drop below $50 per barrel (bbl) all year. Now, the IEA suggests that the projected curve for oil prices will not reach the $50bbl mark until 2023.
While markets will eventually adapt to these new oil price projections, Canada’s reliance on commodities makes it difficult to foresee any substantial immediate gains for the CAD against the USD. The USD/CAD currency pair may have moved in Canada’s favour for much of the year, but crude oil concerns may provoke momentum in the opposite direction.
