FX Watch
Group Economics Macro & Financial Markets Research
3 May 2016
Loonie’s bull run to continue? Roy Teo Senior FX Strategist Tel: +65 6597 8616 roy.teo@sg.abnamro.com
Higher crude oil prices have supported the CAD…
…but the CAD to consolidate in the near term…
…because of technical indicators and the BoC could turn dovish
We expect further upside in CAD because higher oil prices
New forecast: 2016 and 2017 year end USD/CAD: 1.20; 1.15
Recovery in crude oil prices and dovish Fed have supported the CAD Since the beginning of this year, the Canadian dollar (CAD), nicknamed the loonie has rallied from 1.45 to below 1.25 against the US dollar for several reasons. First crude oil prices (WTI) have staged a strong recovery from USD 27 per barrel to above USD 45. This has improved overall sentiment in financial markets and has also given a strong boost to currencies of oil exporting countries. Oil exports account for almost 20% of total Canadian exports.
Recovery in crude oil prices has supported the CAD Level
Reverse scale USD/barrel
Speculative futures positions have turned positive Level
Reverse scale Number of contracts
1.5
20
1.45
-100000
1.4
40
1.35
-50000
60
1.25
80
1.15
1.0
100
1.05
0.9 Jan-09
120
0.95 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
1.3 1.2 1.1
Jul-10
Jan-12
USD/CAD (lhs) Source: Bloomberg
Jul-13
Jan-15
WTI oil (rhs)
0 50000
USD/CAD (lhs)
100000
Non-commercial positions (rhs)
Source: Bloomberg, CFTC
Moreover, financial markets have priced out the odds of further monetary stimulus from the Bank of Canada (BoC). Non-commercial net futures positions have also turned net short to net long. In addition, expectations of rate hikes in the US have been further
Insights.abnamro.nl/en
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FX Watch – Loonie’s bull run to continue? 3 May 2016
scaled down after the weaker-than-expected Q1 US GDP. As a result, the US dollar fell considerably.
We expect consolidation in the near term… Based on sentiment indicators, the rally in the CAD is overdone in the short term, . In addition, crude oil prices have reached our second quarter forecast of USD 45. Technical indicators (relative strength index) also imply that the CAD and crude oil prices are near overbought territory. As a result we expect USD/CAD to consolidate around current levels of 1.25 in the second quarter of this year. The CAD has breached our 2016 year end forecast of 1.26 against the USD. The CAD is likely to extend its outperformance against the USD over the course of 2016 and 2017. However, we do not expect strong gains in the CAD for the following reasons. First, there is downside risk to the Bank of Canada’s (BoC) GDP forecast this year given our view that the US economy is likely to expand at a slower pace of 1.7% versus the central bank’s forecast of 2%. Second, after a slow start to the year, we expect the US economy to expand at a faster pace in the coming quarters while the BoC expects that the Canadian economy will moderate over the course of this year. As a result, interest rate differentials between the US and Canadian economy is likely to widen in favour of the USD. This should slow gains in the CAD as crude oil prices firm. Last but not least, the strength in the CAD is likely to be a headwind to exports and to dampen the inflation outlook in Canada. At the last monetary policy meeting on 13 April, the BoC has assumed that the CAD will be almost 6% weaker (USD/CAD rate of 1.32) than current levels (1.25). In addition, the recovery in the CAD trade weighted index (TWI) has been sharper than Canada’s commodity export prices. Hence in the coming months, the BoC may warn that further gains in the CAD if sustained will hinder the recovery in the economy. However the hurdle rate for the BoC to return to an easing bias will require a significant new shock given that the negative effects of oil shock is likely to bottom out this year. Hence we maintain our view that monetary policy will remain unchanged in 2016.
…and more upside in the course of 2016 and 2017 However the CAD is likely to further strengthen towards 1.20 by the end of this year because we expect crude oil prices to rise further. Moreover, financial markets are still pricing in a 40% probability that the Fed may hike rates by 25bp this year. Our base scenario is that the Fed will keep monetary policy rates on hold in 2016. In 2017, financial markets have priced in our view that the Fed will tighten monetary policy by 75bp. A continued recovery in crude oil prices should continue to support sentiment in the CAD towards 1.15 in 2017.
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FX Watch – Loonie’s bull run to continue? 3 May 2016
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