The swing of record proportions in global investor sentiment toward the Canadian dollar last week – from bullish to bearish – may be best explained by similar patterns in crude futures markets.
In a report released Friday, Scotia's chief foreign exchange strategist Shaun Osborne wrote, "the recent accumulation of net CAD longs (despite weak CAD price action) suddenly – and for little obvious reason – switched to a large net CAD short as gross longs threw in the towel… We believe this to be the largest week/week swing (equating to around 46k contracts) in net CAD positioning ever."
The chart below offers what is at least a partial explanation for the abrupt shift to bearishness on the loonie. Using data from the U.S. Commodity Futures Trading Commission, the lines represent net futures positioning – contracts betting on price increases minus those that benefit from price declines – for the Canadian dollar and West Texas Intermediate crude. The "non-commercial" designation indicates futures contracts held by asset managers, and this data is used as a proxy for hedge funds.
It would be unfair to say that futures positioning in the loonie has "mirrored" crude futures markets, but a consistent association is clear in the chart. During the last portion of the chart, from early December, 2016, to the present, the two lines have tracked more closely. The about-face in loonie futures coincided with a similar move in oil contracts, as a record number of bullish bets on crude began to unwind.
The recent bearish tilt in Canadian dollar futures appears larger in scale than the move lower in crude, although the much larger size of the oil futures markets makes these comparisons difficult.
I have argued previously that the yield differential between Canadian and U.S. two-year bonds has been the best indicator of the value of the Canadian dollar, but there's no doubt that oil prices figure heavily as a driver of the loonie's value. The speculative and bullish excesses in oil futures markets are now being removed, and as a result we can expect the loonie to remain weak as long as this process continues.
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