USD/CAD: Lower on Oil and Valuation – Danske Bank
Jens Nærvig Pedersen, Senior Analyst at Danske Bank, suggests that the pressure on the Canadian economy is mounting from weakness in the US as well as the global economy, low commodity prices and a hesitant stance on monetary policy from the Bank of Canada (BoC).
“Consequently, employment growth has halted and a slight rise in the unemployment rate is trending upwards. Inflation on the other hand remains relatively stable and close to the BoC’s target. However, inflation expectations have been trending lower, which suggests downside risk to inflation outlook.
Monetary policy. The BoC remained on hold in March, taking the view that there was a balance of risk regarding the outlook for inflation. On the one hand, the recent rally in the oil price will lend some support to economic activity and inflation, which supports the BoC’s analysis that current monetary policy is appropriate.
On the other hand, declining inflation expectations and a stronger CAD suggest that the BoC is running the risk of not meeting its inflation target. The market is putting a 40% probability on a 25bp cut from the BoC this year.
Oil constitutes a substantial part of Canadian activity and is generally high-cost. Canada thus stands to lose from a new and lower normal level for the oil price. A large share of Canada’s oil is of a poorer quality and trades with a substantial discount to WTI.
Risks. A sudden uptick in oil prices would comfort the BoC. The BoC is set to renew its monetary policy target at end-2016.
The oil price has rallied on the re-pricing of the path of Federal Reserve rate hikes this year and next year and a decline in USD. Both factors have weighed on USD/CAD over the past month. We see stable USD/CAD in the short-run as we expect oil prices to stay around the current level. On 6M-12M, a recovery in oil prices, a stronger external economic situation and valuation would send USD/CAD lower.”
(Market News Provided by FXstreet)