Financial Advisor

Should USDCAD be higher?

A little focus on the neglected USDCAD pair, which continues to bide its time below parity. Considering the sell-off in crude prices today and developments in interest rates, should the pair be trading much higher? Today we have a look.
Oil prices are not oil prices
Before we discuss USDCAD versus oil prices, we have to realize that everything depends on which oil prices we are talking about. Canada exports much of its oil to the US, where prices are based off the WTI benchmark, one that is highly dependent on the inventory levels at Cushing, Oklahoma. With an absolute glut there, the price of WTI has been in a virtual freefall for the last week or more. Much of the rest of the world uses prices based on other benchmarks – like North Sea Brent, one of the better known alternative benchmarks. While . This is extraordinary, as Brent is an inferior grade of oil that normally trades for a slight discount to higher crude grades like WTI. Today, in fact, the spread between the two grades was a record 11 dollars a barrel.
Below we  have a look at USDCAD (inverse) versus WTI crude, which suggests that the pressure should be to the downside on the Loonie relative to the greenback.
 Against Brent, the picture is less clear and it would be helpful for USDCAD upside if world oil markets were a bit more in synch as it is easy to argue that the local supply glut in the US is a temporary thing. It is worth noting that today, Brent saw a rather steep sell-off after trading at a new high for the recent cycle.

Interest rate spreads and other factors.
Here, we see more convincing evidence that the pressure is on the CAD to depreciate if we use a measure like the 2-year interest rate spreads, which are much tighter than they were trading two weeks ago, when they were at the widest for the cycle.
Chart: USDCAD vs. 2-year rate spread

As for central bank guidance, while we know that the Fed seems on permanent hold forever, the Bank of Canada is loathe to touch interest rates with the CAD at such strong levels and with its terms of trade heading sharply in the wrong direction over the last couple of years (to an outright trade deficit.) Just today, the BoC’s Carney was out saying that he is comfortable keeping rates at recent low despite food inflation globally and that the “thing that keeps him up at night is that in this rebalancing of global demand, the Canadian current account has swung 6 percentage points of GDP in the last three years, from a 2% surplus to a 4% deficit.” It doesn’t look like we should be pricing in any rate hikes just yet.
As for “other factors”, we can mention relative sovereign debt worries and risk appetite as other relevant factors in this market. In the sovereign debt department, it is understandable that the market has a hard time bidding up the USD when the US has shown so little credibility on the austerity front and continues to show a stark fiscal picture. In the meantime, Canada is considered one of the most fiscally solid countries in the world (partly a mirage because of a vastly leveraged consumer sector, but still the case).  Finally, risk appetite remains very robust at present, and this tends to favor a more pro-cyclical currency like CAD over the USD.
Long story short – by a couple of measures (interest rate spread and WTI oil prices), USDCAD looks underpriced, but we would like to see an expansion in risk aversion and a more pronounced sell-off in non-WTI oil and other pro-cyclical commodities like copper if we are to see USDCAD rally again above and beyond the parity level.
Another story: AUDCAD
On the pro-cyclical commodity front, it is interesting to note the AUDCAD pair, which we plot here relative to the copper/Brent crude oil ratio. Aussie has been in trouble a bit lately, but risk appetite and copper have kept it from a steeper drop. Either of these legs being removed could trigger a tumble in the Aussie – even against CAD, as we suspect the potential downside for copper is larger than for crude. While copper is strong on physical buying related to warehousing and financialization, crude will never be financialized the same way and we wonder how long the copper bubble can continue before it pops (and if all of the commodity price rises are about distrust in fiat currencies, then crude oil should more than keep pace with the red metal.)
Chart: AUDCAD versus copper/oil ratio

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