U.S. Dollar / Canadian Dollar: Up Against The Odds?

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 |  Includes: FXC, UDN, UUP
by: Evariste Lefeuvre

Thanks to the trend reversal in oil extraction, the US has become a net exporter of petroleum products. This can be explained by the excess of refineries within an economy that is becoming less energy intensive (CAFE restrictions on cars, fewer miles traveled, nat gas…).

Canada also benefited from the oil bonanza, but while net exports of crude oil are on the rise, refined product exports have stalled.

US refiners (Midwestern) can benefit from the Brent/WTI spread and reap the benefits of compelling margins. In Canada, the story is completely different, as the economy does not benefit from the huge price differential between Brent/WCS (Western Canada Select).

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For that reason any attempt to link USD/CAD to either Brent/WTi or WTI/WCS does not work as can be seen below.

Yet, as a crude oil exporter, there is some rationale for the Canadian currency to be driven by crude oil prices.

the first chart below shows that USD/CAD is still highly correlated to Brent prices. Unfortunately, the link has broken down recently.

In addition the pair reacts strongly to the spread of 1-year OIS curves as can be seen below. Here to there is a disconnect.

In both cases, the level suggested for the USD/CAD would be 1 or even 0.99. Is USD/CAD is overpriced then?

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This question is also raised by the disconnect between USD/CAD and what is implied by the relative performance of stock markets (TSX vs SP 500).

The chart below gives some answers. The link between the US minus Canada news flow and the USD/CAD has long been inverted - the reason being that whenever the US situation improved, risk-on sentiment rose, and the USD weakened.

Now the situation looks different, as domestic factors (central banks, news flow, cycle) drive FX pairs (said differently, the FX world has somewhat disconnected from the pure risk on/risk off mechanics).

And as the economic situation is worsening quickly in Canada, there is some space for further USD/CAD appreciation.

The chart suggests that USD/CAD could go up to 1.04/05. This would be consistent with the ongoing economic under-performance of the Canadian economy relative to that of the US.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.