CAD was hit hard on Friday, with USDCAD shooting back above 1.4150 from earlier lows of below 1.40.
Two main things have been weighing on CAD today.
1 - Dovish Bank of Canada
Unexpectedly, the Bank of Canada today cut rates by 50bps, from 0.75% to 0.25%. This unscheduled rate decision brings the policy rate to its effective lower bound (meaning, they will not cut rates any further) and is intended to provide support to the Canadian financial system and the economy during the COVID-19 pandemic, the bank said.
The spread of COVID-19 is having serious consequences for Canadians and for the economy, as is the abrupt decline in world oil prices.
The bank also announced two new asset purchase programmes (effectively, QE);
First, the Commercial Paper Purchase Program (CPPP) will help to alleviate strains in short-term funding markets and thereby preserve a key source of funding for businesses. Details of the program will be available on the Bank’s web site.
Second, to address strains in the market for Canadian government debt and to enhance the effectiveness of all other actions taken so far, the Bank will begin acquiring Government of Canada securities in the secondary market. Purchases will begin with a minimum of $5 billion per week, across the yield curve.
The BoC emphasised that more could be done if needed, which Governor Poloz later clarified meant further QE in the press conference.
What this means for CAD?
Part of what drives FX markets is interest rate expectations. I.e. if the Bank of Canada is expected to have interest rates at 0.75%, while other central banks are expected to maintain lower interest rates, investors will be tempted to hold cash in CAD, as they make more money. That means when a central bank unexpectedly lowers interest rates, as we saw today with the BoC, investors will be surprised and react by moving money out of CAD. This because if they do leave their cash in CAD, they will no longer be making as much money via interest as they previously thought.
The BoC therefore caught investors by surprise by cutting rates and announcing QE today, thus investors reacted by moving money out of CAD. However, investors were expecting the BoC to lower rates at its meeting next month, so rather than the rate cut being a suprise, the timing was a surprise. Had investors not expected a cut at all, we would have seen even more pronounced CAD weakness.
2 - Oil prices have been falling
Oil prices have been getting hammered today.
As we have covered indepth over the past few weeks, ever since OPEC+ failed to agree to a new round of production cuts, the Saudis and Russians have been upping oil production, creating huge downwards pressure on oil prices. Even before the price war, oil prices had been under pressure due to demand concerns due to the Covid-19 pandemic.
However, before today’s price action, crude oil had actually been holding up fairly well this week. The US was known to be upping the pressure on the Saudis to end their price war with Russia and had even proposed the two countries join forces themselves and cut production together. Moreover, US President Trump was pressing for the US Strategic Petroleum Reserve to start buying huge sums of oil to make the most out of the current low prices. These stories had been giving a floor to crude oil’s price action this week.
However, today both of these positives have come to an abrupt end. Firstly, Congress rejected Trump’s attempts to authorise huge crude oil purchases. Secondly, the Saudis have flatly refused to engage with the US regarding “stabilising the oil market”. All the while, dialogue between the Saudis and Russians appears to be all but dead, and the Russians look just as eager to press ahead with output reductions.
We are seeing this come to a head on Friday, with oil prices slumping some 7.5% (in Brent crude futures).
What this means for CAD?
Exports of crude oil make up a significant percentage of the Canadian economy. Therefore, the fate of the Canadian economy is closely linked to the fate of oil prices.
This is emphasised by the BoC, who cited low prices as another reason, alongside the Covid-19 outbreak, to ease policy today.
Therefore, when we see oil prices coming under pressure, CAD typically comes under pressure today.
To sum up then, a combination of an unexpectedly dovish BoC combined with oil prices falling significantly has taken its toll on CAD today.
Looking ahead for the loonie (another term by which traders refer to CAD), things do not look good. Oil prices do not have anything going for them at the moment, with demand suppressed due to the pandemic and supply ample due to the price war. Moreover, with CAD a highly risk sensitive currency (it has a correlation with other risk assets such as stocks), risks remain tilted to the downside as the pandemic evolves.
Two things could be a saving grace for CAD, however. Firstly, USD liquidity conditions have significantly improved this week thanks to aggressive Fed stimulus, paving the way for a CAD rebound. As long as USD remains under wraps, a CAD revival always has a chance.
Moreover, with BoC rates now as low as they are going to go, the bank’s options for even more dovish policy are limited. More QE is about all they have left, meaning there is less scope for another dovish surprise that would trigger more CAD downside.
Are you an aspiring trader who finds the fundamentals overwhelming?
We have a brand-new fundamentals course that explains everything in a digestible, easy to understand way. CLICK HERE.
We also have a dedicated team of in-house analysts whose job it is to track, report on and write an up-to-date market analysis on all of the major themes in today’s market. Check out our membership options HERE.