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BIC-For The Canadian Dollar, Not All Spikes In Oil Are Created Equal
Friday, 13 June 2014
The situation in Iraq, where an al Qaeda-inspired group known as ISIS has taken control of sections of the northern part of the country, has left investors around the world on edge.
These geopolitical tensions have led to a bid for gold and oil, pushing the TSX above 15,000 to within a stone’s throw of its record high.
The commodity that has benefited the most from these proceedings is oil, with WTI crude jumping from the $102-103 per barrel range up towards $107 this week.
In a speech delivered in late April, Bank of Canada Governor Stephen Poloz seemed to suggest that there’s a floor on how low the loonie can go if oil sits at lofty levels. Reinforcing this message during his testimony before members of the House of Commons later that month, the governor indicated that there was nothing that the central bank could do to detach the Canadian dollar from the country’s terms of trade.
As such, one might expect the loonie to have enjoyed a sizable rally as these geopolitical tensions began to seize the market’s attention. While the currency has gained against the greenback over the past week, the pair’s move has been inconsequential compared to the pick-up in crude.
We spoke with Ken Wills, currency strategist at CanadianForex, to learn why the loonie hasn’t surged along with oil.
“What we’ve seen over the past few days would highlight that the correlation between oil and the Canadian dollar varies, depending on what’s fuelling the rise in oil,” he said. “When it’s a geopolitical risk, as we’re seeing now, it’s more of a support for the loonie, but if oil were trading at this level based on a stellar growth outlook for China, it would be more of a driver of Canadian dollar strength.”
The ‘flight to safety’ that comes along with rising geopolitical concerns also tends to lead to buying of the U.S. dollar.
As such, Ken sees limited upside for the loonie to make a huge break higher. He told us that there’s an “awful lot” of orders between the Canadian dollar’s current level (USDCAD ~1.086) and the May lows, which suggests that any decline in that pair would be a slow grind.
The ‘short loonie’ trade, which was one of Goldman Sachs’ top three trade recommendations for 2014, started strong but looks to have run out of steam.
“The weekly positioning reports have definitely showed that the short CAD position has come in a bit,” he told us. “I think a lot of people stormed into that trade in January and ended up getting a little tired of it.”
Ken also offered his thoughts on why recent inflation readings, which have showed the metric trending upwards and the headline rate sitting at the midpoint of the Bank of Canada’s 1 to 3 percent target range, haven’t provided much fuel for CAD appreciated.
Poloz has “conditioned” the market not to flinch on these unexpectedly high levels of inflation, he says, by emphasizing that the rise has been driven by temporary factors that will not alter the Bank’s stance.
From Business In Canada
