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‘Buckle up’: It would take $100 oil to stop the Canadian dollar from skidding to 75¢
Michael Babad

This article was published more than 6 years ago. Some information may no longer be current.

Briefing highlights

  • Loonie seen sinking to 75 cents
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'Time to buckle up'

Here's a fascinating takeaway from Bank of America Merrill Lynch: Oil would have to top $100 (U.S.) a barrel to stop the Canadian dollar from skidding to about the 75-cent mark.

There's a lot for the loonie to digest at this point, including the difference in interest-rate scenarios for the Bank of Canada and the Federal Reserve, the antagonism at the NAFTA bargaining table, and a handful of other things.

But the divergence between the Canadian and U.S. central banks is the biggie that will help drive down the loonie over the next three to six months, according to Bank of America's G10 foreign-exchange strategist, Ben Randol, its Canada and Mexico economist, Carlos Capistran, and technical strategist Paul Ciana.

"In our view, U.S.-Canada monetary policy divergence over the next several months is likely to translate to around 5 per cent upside in USD/CAD, suggesting a retest of about 1.33," they said in a new outlook this week, with USD/CAD meaning the greenback versus the loonie.

And by upside for the U.S. versus the Canadian dollar, they mean downside for the loonie, the 1.33 translating to a level just above 75 cents.

"Sensitivity of USD/CAD to oil prices has diminished significantly," said Mr. Randol, Mr. Capistran and Mr. Ciana.

"It now takes a 10-per-cent move in crude oil to move USD/CAD 0.5 per cent higher."

Given the loonie's reduced sensitivity to West Texas intermediate crude, the U.S. benchmark, "we estimate that it would take WTI above $100/barrel to fully offset the bullish USD/CAD impulse we see happening over the next three to six months from our projected Fed-BoC policy interest rate path within the context of long CAD positioning per CFTC," Mr. Randol said later.

Mr. Randol was referring to tracking by the U.S. Commodity Futures Trading Commission (CFTC), whose latest report showed a net speculative long position in the Canadian dollar of about $4-billion.

And, not to belabour the point, but bullish here is like upside earlier: That would be bearish for the loonie.

"We used the >$100/barrel scenario to illustrate what it would take from oil to offset this impulse from the monetary policy channel," Mr. Randol said.

"If WTI were to keep grinding higher, this would dampen upside potential below the 1.33 level, but, as mentioned, because oil sensitivity is so low we doubt that the offsetting bearish USD/CAD impact would be all that material except in the case of a rapid move above $100."

The Fed, of course, is in the midst of a hiking cycle for its benchmark Fed funds rate. The Bank of Canada, in turn, is now in wait-and-see mode, having raised its key overnight rate twice this year before calling a halt, at least for now. When you put those two facts together, it's not exactly a loonie-friendly scenario.

Bank of America expects the Fed to raise rates again in December, and yet again early next year. It sees the Bank of Canada moving in January, April and July of 2018, but possibly moving slower.

"The BoC is also monitoring the actions of the Fed. We expect the BoC to follow the Fed but without setting rates above Fed funds in order to prevent unwanted CAD appreciation."

That's because a weak loonie helps spur exports, and a bounce in exports is something the central bank wants to see.

Saying it's "time to buckle up" where the loonie's concerned, Mr. Randol, Mr. Capistran and Mr. Ciana cited the potential for a "squeeze" for those long positions.

"We see a defined window over the next several months in which U.S.-Canada monetary policy divergence sparks a position unwind that fuels sharp appreciation in USD/CAD," they said, adding "we doubt that potentially higher oil prices - if realized - could stop this."

And, yes, the sharp appreciation here means depreciation for the loonie.

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