Canadian Dollar Support May Be Fleeting As Rising Inventories Threaten Oil Prices

USD/CAD

A return of risk appetite helped end the Canadian dollar’s two day losing streak to the greenback as Fed Chairman Bernanke signaled that U.S. interest rates will remain on hold for an extended period. A drop in US consumer confidence had sunk demand for risky assets yesterday which sent the USD/CAD higher. Today’s reversal in oil prices is weighing on the pair as it is currently explaining 56% of price action. Crude’s influence on the pair had slipped to 45% before Greece’s credit issues generated broader swings in risk trends which increased correlation across the board. Canadian interest rate expectations have seen their correlation with price action increase to 14% from 2% a week ago as they both trended lower throughout the month. However, with the BoC expected to remain on hold, yield expectations has very little credibility as a driver of price action.

BoC Interest Rate Expectations

Overnight Index Swaps are now only pricing in 68 bps of a rate hike by the BoC over the next twelve months as policy makers have been firm with their commitment to keeping rates on hold until the second half of 2010.  Canadian consumer prices rose to 1.9% in January from 1.3% the month prior which is below the target level of 2%. Inflation is showing signs of accelerating and a strong labor market and domestic demand (retail sales rose 0.4% in December) should continue to fuel price growth. BoC Governor Carney recognizes that the Canadian economy is in better shape than its developed counterparts, but policy makers remain cautious as its growth is still tied to the global economy. In a recent speech the central bank leader stated” Once the recovery is assured, most economies will need to make concerted efforts to restore fiscal sustainability. But with the debt-to-GDP ratio in industrialized countries expected to rise from 80 per cent, pre-crisis, to 120 per cent by 2014, this challenge should not be underestimated”. The upcoming 4Q GDP report is expected to show a 4.5% increase which would be impressive considering that the Canadian government hasn’t incurred a huge budget deficit to stimulate its economy as some of its counterparts. The robust growth figures could raise the outlook for a rate hike and generate “loonie" support. To discuss this and trading ideas join the USD/CAD forum.

FOMC Interest Rate Expectations

Fed Chairman Ben Bernanke reiterated the central bank’s commitment to keep rates on hold today which weighed on the dollar. Fed Funds are only pricing in a 6.4% chance of a rate hike by April with a no chance at the March policy meeting. It isn’t until November that the chances of tightening exceed those of the FOMC remaining on hold. U.S. durable goods orders for January are due to cross the wires tomorrow with expectations of a 1.4% rise. Strong demand for long lasting items is a sign of improving optimism and potential growth. However, the labor market remains the biggest concern for investors and the weekly initial jobless claims report could prove greater event risk with the NFP report due out next week.

Oil

Oil is currently in an ascending channel which could lead to additional gains as it looks to test the upper bound. Yesterday’s sharp decline on the back of growing pessimism shows that traders are reluctant to become overly bearish as global growth continues to improve.  A string Durable goods report will only improve the outlook for future consumption and could generate additional support. However, crude prices above $80 are detrimental to growth and are generally followed by economic downturns. Therefore, markets may be reluctant to push prices much higher without supporting demand. U.S. crude oil inventories rose by 3 million barrels last week despite the cold spell across the country. Economists were looking for a rise of 1.9 million following a 3.1 million increase the week prior. The buildup could become a weighing factor for oil and the Canadian dollar. Discuss this and other fundamental data join the Economics Forum.

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