Oil has hit a 15-month high on the back of optimism over the Opec deal which needs to be sorted out by November 30. But, with a record long position building across the combined benchmarks, a disappointment could leave some exposed. Full report to come within the hour....
Article / 26 July 2016 at 23:04 GMT

USDCAD: Oil in driver's seat while the Fed co-pilots

FX Consultant / IFXA Ltd
  • FX traders are suffering from pre-FOMC jitters
  • US data does not preclude a hawkish FOMC statement
  • Falling oil and a rising dollar is a bad combination for the loonie

By Michael O'Neill

It has been a sweltering couple of weeks over large swathes of the northern hemisphere and we haven’t even hit the half-way mark of summer. WebMD lists dizziness, rapid heartbeat and behavioural changes such as confusion as symptoms of heat stroke.

 Who's flying this plane? When it comes to the loonie, oil is in charge. Photo: iStock

Those same symptoms have been seen in FX markets, with USDJPY in particular. Two weeks ago, USDJPY was probing support in the 100.00 area. The big question was how far it could fall before it triggered Bank of Japan intervention. That changed with Japan’s Upper House election. Prime Minister Shinzo Abe’s Coalition won a “super majority” and he immediately announced a new round of fiscal stimulus measures. USDJPY embarked on a nine-day rally that ended at 107.50 helped by stories of bigger-than-expected spending.

And then, heatstroke. USDJPY plunged. Dollar bulls apparently remembered how the FX market reacted in January when the Bank of Japan announced negative rates and feared that the expected next round of BoJ stimulus would have the same result.

Oil traders were out in the sun as well. Weekly draw-downs of crude stocks as reported by the Energy Information Administration had many believing that the earlier price declines were merely position adjustments and not evidence that the supply/demand imbalance was still an issue. That belief is evidence of heatstroke considering that WTI is currently sitting at $42.56/barrel.

The loonie is not the master of its destiny

There is a lot to like about the Canadian dollar but you wouldn’t know it from the recent price action. If USDCAD traders were to be believed, the only thing that Canada has going for it is oil and since oil is dropping, so should the Canadian dollar.

Those traders are wrong. There is more to Canada than oil.

Aside from the oil patch, the Canadian economy is more than holding its own. The improving outlook for the US economy, the destination of close to 75% of all Canadian exports, bodes well for the domestic economy. The Bank of Canada is forecasting 3.6% Q3 GDP growth and last week the province of Ontario (largest by population) reported 3% GDP growth. 

Consumers are spending. May retail sales rose 0.2%, slightly above expectations. Inflation gained as well. The ever-present housing market bubble concerns may alleviate, to a degree, thanks to a new foreign buyers' tax that kicks in August 2. Foreign buyers of residential real estate in the Greater Vancouver area will be levied an additional 15% property transfer tax.

But it doesn’t matter. Oil is in the driver’s seat and the Fed is its co-pilot.

Aside from oil, the other major driver of USDCAD direction is the US interest rate outlook. Wednesday will provide more clues when the Federal Open Market Committee statement is released. An MNI news article recapped comments from various Fed members since the last meeting which suggests a rather undecided committee. A June rate hike appeared to be a ”done deal” until Brexit and a lousy labour report derailed the view. Since then, the June nonfarm payrolls report completely erased the taint of the May report and the immediate Brexit fallout has been contained.

A hawkish FOMC statement in the present environment of declining oil prices warns of a much higher USDCAD.

USDCAD technicals-highway to the danger zone

Oil prices are threatening to break below key support at $42.35, which would lead to a test of $40.0 while USDCAD is probing resistance in the 1.3240 area. That’s a dangerous mix for the loonie. In addition, 1.3285 is setting up to be the line in the sand. A break above that level suggests additional gains with 1.3650 as a stretch target. Only a move below 1.3065 would negate the topside pressure.

USDCAD and oil
 Source Saxo Bank. Create your own charts with SaxoTrader; click here to learn more 

– Edited by Gayle Bryant

Michael O'Neill is an FX consultant at IFXA Ltd. Follow Mike or post your comment below to engage with Saxo Bank's social trading platform.


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