Canadian Dollar Soars On Higher Oil, But Will Crude Run Out Of Steam?

USD/CAD

The USD/CAD remains under pressure as anti-dollar sentiment, improving Canadian fundamentals and rising oil prices have fueled bearish sentiment. Crude prices continue to be the main driver of price action for the pair and currently are explaining 63% of volatility. Bank of Canada interest rate expectations have grown in importance and are now accounting for 35% of bullish “loonie” sentiment. Strong employment figures and stickier than expected consumer prices, have helped raise yield forecasts despite the central bank’s contention that he y will remain on hold until mid-2010.

BoC Interest Rate Expectations

BoC interest rate expectations have soared to as high as 112 on the back of improving fundamentals and a brighter outlook for global growth. Traders are starting to bet that the threat of inflation will follow improving demand. The Canadian economy added 30,600 jobs in September with employers making a stronger commitment to full time hires. The strengthening labor market could give rise to future wages which is a man contributor to inflation. Higher wages should fuel demand and in turn consumer prices unless post crisis behavior leads to an increase in the savings rate. The central bank continues to express their dissatisfaction with current “loonoe’ strength and have cautioned that it is beginning to threaten the country’s recovery. Therefore, we could see the interest rate outlook decline as policy makers may look to keep rates despite emerging signs of inflation. 

FOMC Interest Rate Expectations

Fed funds futures are currently pricing in a 6.5% chance of a rate hike by the end of the year which is the highest in over a month. Additionally, markets also raised the likelihood of a 75 bps rise in the target rate in January to 1.8% but simultaneously lowered the overall chances of tightening from 30.4% to 23.7%. The FOMC may remain on hold longer than previously expected which could increase the chances of an aggressive move once they decide to tighten. The Fed beige book report showed that there was modest improvement in most districts and that signs of stabilization are increasing. However, there was still eroding credit markets, weak consumer demand and subdued price pressures across most districts which most likely keep the FOMC on hold through early 2010.

Oil

Oil has continued to trend higher as the recovering global economy has raised the outlook for future demand. Indeed, crude found support today when the U.S. Department of Energy showed a bigger than expected decline in gasoline inventories. Supplies fell 2.2 million barrels to 339.1 million versus forecasts of an increase of 1.5 million. The price of crude has broken above $80 bbl for the first time in a year which leaves open the possibility of a retrace if markets deem that underlining fundamentals don’t justify the lofty valuation. However, if we see a repeat of the behavior before the crisis took hold then the breach of the psychological level could fuel speculative interest. Additionally, OPEC recently raised their forecast for world oil demand by 200,000 barrels per day for the remainder of 2009 and 2010. Therefore, unless the oil cartel decides to increase production or the global recovery takes a turn for the worse, prices should continue to find support. Yet, upside potential may be limited until the scope of the recovery can be gauged.

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com