CAD, Oil And The 2-Year Interest Rate Differential
Marc Chandler | Aug 04, 2015 23:53
Over the last 100 sessions, the Canadian dollar and oil (front month light sweet crude) have moved in the same direction about 79 times. From the middle of November 2014 through mid-January, the relationship was even tighter, at about 95 days on a rolling basis.
However, the capital flows into and out of Canada swamp the value of oil exports, which are also offset by the fact that provinces in the east import oil. In fact, the traditional pattern has been for the eastern provinces to import more expensive Brent oil, while a few western provinces export cheaper oil to the US. In 2014, Canada exported about $105 bln of energy products and imported about $46 bln of energy products. Let's not forget that Canada is an important exception to the US ban on oil exports.
The importance of oil for the Canadian dollar is not just about the value of its single largest export but it is a more general proxy in the current environment for the overall Canadian economy, which had become highly leveraged to oil prices. It was an ATM, like US home equity loans, that bolstered consumption, investment and asset prices. The Toronto Stock Exchange Composite is the only major equity market that is lower thus far this year, for example.
This Great Graphic, composed on Bloomberg, shows the Canadian dollar (yellow line) and the two-year interest rate differential (white line) between the US and Canada over the past year. The big rise that took place in both time series in January was not the result of oil prices, which were putting in a temporary bottom, but rather the Bank of Canada's surprise rate cut. Today the US premium is almost 29 bp, the most since July 2007.
Following news that the Canadian economy unexpectedly contracted, there has been renewed speculation that the central bank will likely have to cut interest rates again. At the same time, the Federal Reserve has confirmed its intention to raise rates later this year, provided the labor market shows "some" more improvement.
The fact that the two central banks are moving in opposite directions is a weight on the Canadian dollar. The decline in oil prices is a factor influencing the economy, which is what the Bank of Canada is interested in when setting policy. Policy is what investors appear particularly sensitive to in the current environment.
Get The App
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.