Canada Leads World in Commodities Link, to Loonie Bears' Delight

  • Loonie most linked to key export among 16 major currencies
  • Cheap oil, monetary easing seen keeping Canadian dollar weak

Where the price of oil goes, so goes Canada’s dollar.

No other major currency is as closely tied to the value of its key commodity export as the loonie is to crude right now. The correlation between the Canadian dollar and the benchmark West Texas Intermediate oil price is about 0.56, meaning the two have a strong positive relationship. That’s the closest association among 16 of the world’s most-traded currencies including the Australian and New Zealand dollars, Norway’s krone and Brazil’s real.

With oil futures trading below $45 a barrel through 2016, the loonie may continue to struggle. The currency, named for the image of the aquatic bird on the C$1 coin, has declined 16 percent over the past year, touching an 11-year low of C$1.4001 per U.S. dollar last week. The drop comes as the price of WTI fell to the lowest since 2009 after the Organization of Petroleum Exporting Countries announced this month it was abandoning production limits.

"Obviously the slump in oil prices that we’ve seen over the past year has really affected economic conditions in Canada, affected the outlook for monetary policy and by consequence affected the Canadian dollar," said Shaun Osborne, chief foreign-exchange strategist for Bank of Nova Scotia, by phone from Toronto. "It’s important for exports, it’s important for business investment, it’s important for the health of the economy."

Aussie, Kiwi

The 120-day correlation coefficient between 16 major currencies tracked by Bloomberg and their country’s main export commodity -- based on 2014 World Bank data -- show that the Mexican peso and oil had the second strongest correlation, at 0.41. The correlation between the Australian dollar and iron ore was 0.13, while the link between New Zealand’s currency and whole milk powder was 0.11. A reading of 1 means that gauges move in lockstep; minus 1 means they move in opposite directions.

Crude fell below $34 a barrel on Dec. 21. WTI futures for delivery in March are trading at about $38, compared to $40 for those settling in June.

The loonie climbed 0.4 percent to C$1.3867 per U.S. dollar at 11:58 a.m. Toronto time Wednesday after a a report showed U.S. crude inventories declined, easing a supply glut. One Canadian dollar buys 72.11 U.S. cents.

The Canadian dollar has already fallen below Scotiabank’s 2016 target of C$1.39 this month and there is "clear risk of an overshoot" toward C$1.42-C$1.43 through the first quarter, Osborne said.

Extraordinary Measures

The growing risk of another Bank of Canada interest-rate cut in 2016, after the bank lowered rates twice this year before setting the benchmark at 0.5 percent, adds another layer of uncertainty on the loonie, said John Shin, a Group-of-10 foreign exchange strategist at Bank of America Merrill Lynch in New York. Bank of America sees the loonie reaching C$1.45 in the first quarter of next year and C$1.40 by the end of 2016 on risks of low oil prices and possible further monetary easing.

"It is more of a concern for the market if they wind up doing the type of unconventional policies that they were able to avoid during the financial crisis," Shin said.

Bank of Canada governor Stephen Poloz has said the bank is far from needing extraordinary measures such as negative interest rates.

Matt Weller at Gain Capital Holdings Inc.’s unit in Grand Rapids, Michigan, isn’t so sure.

“Many of the tar sands and the ways of extracting oil through Canada are much
less economic and therefore traders are looking a step ahead,” Weller said. “This weakness in oil will lead to a more dovish posture from the Bank of Canada, potentially raising the specter of more interest rate cuts, which no one expected at the beginning of this year.”

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