Canadian Dollar Falls to 5-month Low as Oil Surges
Canadian Dollar Falls to 5-month Low as Oil Surges
The Canadian dollar decouples from oil. As Canadian dollar traders lose a vital oil signal, what should they focus on?
- The Canadian dollar (/6c) loses a vital signal in oil prices.
- Why is the U.S. dollar driving price action in the Loonie?
- What should traders know as the key correlation breaks down?
Unlike the U.S. dollar, which is fortified by a service-oriented yet deeply diversified economy, the Canadian dollar traditionally fluctuates in tandem with the price of crude oil, Canada's largest export. However, this relationship has recently diminished, a cause for concern given the recent surge in oil prices.
The correlation coefficient of the Loonie, a statistical measure of how two variables move in relation to one another (where 1 signifies a perfect positive relationship and -1 indicates a perfect negative relationship) against West Texas Intermediate (WTI) oil, has averaged 0.46 since September 2019. This figure represents a strong positive correlation. However, this measure plummeted to -0.43 in early September.
Despite a slight increase in Canadian crude oil exports over the last year, the decline does not justify the sharp selloff in the Canadian dollar (symbol: /6CU3), particularly considering the current oil prices. Since the beginning of August, /6CU3 has depreciated by 3.3%, hitting a five-month low, while crude oil (/CLU3) has appreciated by over 7%.
What explains this divergence?
Several factors are propelling the current market trends, with the primary force stemming from interest rate expectations in a faltering Canadian economy. The Bank of Canada (BoC) appears to have concluded its rate-hiking cycle. On Sept. 6, the BoC maintained its benchmark rate, signaling the end of its rate-hiking phase. Swap traders concur, as market pricing leans towards no additional rate hikes.
This decision was foreshadowed by Canada's gross domestic product (GDP) for the second quarter, which experienced a 0.2% decline on an annualized basis, falling short of analysts' expectations of a 1.2% growth. In contrast, the U.S. manufacturing sector demonstrated expansion, buoyed by a robust labor market. Given that /6C futures are significantly influenced by the dollar, this development exerted pressure on the Loonie.
What do traders need to know
The divergence between oil prices and /6C is no longer a reliable indicator for trading Canadian dollar direction. While Canada exported roughly 3.97 million barrels per day (Mbbl/d) in June, up from 3.85 Mbbl/d from a year ago, it hasn’t helped /6C from plummeting over the past 5 months.
Instead, traders may want to focus more on the U.S., its currency and influencing factors there such as Treasury yields, economic data and monetary policy decisions until the correlation returns to positive territory.
Thomas Westwater, a tastylive financial writer and analyst, has eight years of markets and trading experience. @fxwestwaterFor live daily programming, market news and commentary, visit tastylive or the YouTube channels tastylive (for options traders), and tastyliveTrending for stocks, futures, forex & macro.
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