Canadian Outlook Hampered By Resurgent Energy Glut

After managing a modest improvement during the first quarter of the year alongside the rally in oil prices that transpired during the first half of the year, the renewed slide in prices threatens to undo all the gains Canada realized. As one of its principle exports, crude oil prices remain systemically important to the nation’s outlook, especially the value of the Loonie. The renewed downturn in prices which just recently slipped back below $40.00 per barrel for the first time since April underscores the mounting concerns about the outlook. However, the result may potentially be a Central Bank that is powerless to act to accommodate conditions in the economy, especially with upside inflationary pressures remaining largely intact. Barring another rally in energy prices, the Canadian dollar is likely to continue sliding alongside deteriorating economic fundamentals.

Oil Imbalance Set to Persist

Although the summer US driving season helped offset concerns about the pace of rising inventories, especially after 9-straight weeks of drawdowns, the recent inventory build reported by the Energy Information Administration threatens to spark another round of concern about onshore storage. With OPEC production rising to a record and Canadian output forecast to rise through the remainder of the year, the imbalance that forced oil prices lower over the last two years has reemerged. While the fire that raged in the Fort McMurray region of Canada took nearly 1.500 million barrels per day of output offline, helping temporarily reduce the imbalance, now that production has returned to normal, the stage is set for revived oversupply. Hurting the outlook even further is reduced refinery demand amid the surplus of gasoline and other distillates.

For Canada in particular, the falling price of crude oil has created numerous problems for the economy. While the government was quick to act, helping to offset the pain inflicted on the oil patch with fiscal stimulus, the impact of these measures has been limited. The precipitous drop in the price of oil and parallel slide in the Canadian dollar has seen inflation remain elevated, hurting the Bank of Canada’s ability to act on rates even though they are forecast to fall in the fourth quarter. However, the fallout from lower oil prices is spreading beyond just inflation, also harming employment and broader growth with Canadian GDP decelerating to the weakest pace of expansion in 60 years. With growth not expected to accelerate near-term considering the energy backdrop, the Canadian dollar is likely to remain under pressure as a result.

Oil Stokes Loonie Losses

Following a dramatic improvement in the value of the Canadian dollar after the currency fell to its weakest point in over a decade near the beginning of 2016, the currency is once again on the slide, echoing the losses in the crude oil prices. On a side-by-side basis with West Texas Intermediate futures, the USDCAD currency pair is currently sporting a correlation coefficient of -0.5527, implying a moderately strong inverse relationship. Should oil prices continue to slide after breaching the psychological level at $40.00 per barrel, USDCAD could continue to climb in tandem with the losses as Canadian oil revenues fall. Even though the US dollar has been under serious pressure after a bout of poor fundamental data, preventing a massive appreciation in the USDCAD pair as oil prices plumb a fresh bear market, should this pressure be alleviated, it paves the way for significant USDCAD rally.

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On a more near-term basis, indicators are more in their outlook. Although the medium-term 50-day moving average reversed higher and is currently acting as support, the 200-day moving average remains above the price action, acting as resistance against a prolonged rally in the USDCAD pair.Additionally, the 200-day moving average happens to coincide with the upper channel line of an equidistant channel pattern. USDCAD has been trending with an upward trending channel sporting a bullish bias since the beginning of June. In terms of trading the channel, positions established near the lower channel line should target the upper channel line for an exit. However, trading against the near-term trend may not be productive considering the worsened reward characteristics. Additionally, with the 200-day moving average acting as resistance, no prolonged uptrend can endure without a candlestick close above this critical level.

Looking Ahead

Upcoming data on employment due from both the United States and Canada later in the week will undoubtedly have a notable influence on the USDCAD pair. While the US dollar has been facing losses in the aftermath of last week’s disappointing GDP figures, any strong nonfarm payroll figure on Friday could heighten rate hike speculation, helping the US dollar to appreciate further. However, in the case of Canada, lower oil prices will probably contribute to sustained losses in the labor market, adding to the list of problems facing policymakers. Even though no imminent action is expected on monetary policy for either country, should oil prices continue to slide, the stage is set for USDCAD to continue rallying to the upside over the medium-term.