The Canadian Dollar Could Stage A Comeback: USD/CAD And EUR/CAD To Fall

Summary

• The Canadian dollar is correlated with commodities such as oil and copper, by virtue of Canada's export exposures to energy and metals.
• Coronavirus headlines have battered commodity prices recently. However, should markets gain greater certainty surrounding this emergent epidemic, commodity prices are likely to find continued support.
• Continued support is likely to, in turn, support the Canadian dollar. With CAD having found greater weakness recently, alongside oil prices especially, it appears to offer a contrarian long opportunity.
• One may wish to consider being short USD/CAD and/or EUR/CAD, and perhaps especially the latter, given the wide interest rate differential which remains between the Bank of Canada and the ECB's short-term rates.

The Canadian dollar has fallen in recent times, alongside oil prices. The currency of Canada is correlated positively with oil prices, by virtue of Canada's export exposures to oil-related products. The chart below indicates that mineral products (i.e., including crude petroleum and refined petroleum, among others) represented over 24% of all Canadian exports in 2017.

(Source: Observatory of Economic Complexity)

It is also worth noting that transportation products (including cars and vehicle parts) represented a further 19% or so of Canadian exports. Meanwhile, metals represented over 8% of total exports (this includes aluminium-related products, as well as refined copper, copper wire, and plenty of other finished and intermediate metal products). The reason why we should note these other categories is because the demand for these are generally expected to correlate with the demand for oil.

Oil, metals and transportation products together represent over 50% of total exports. That is a significant portion; an exposure large enough to make the Canadian dollar a "commodity currency" (i.e., a currency which is correlated with commodity prices, and associated with risk-on activity). Indeed, while oil does not make Canada (Canada's exports are varied), the country's exports are mostly likely to benefit from the "upswing" (or growth phase) of a typical business cycle.

Speaking more straightforwardly: if economic growth is positive and/or markets anticipate positive economic growth, the Canadian dollar is more likely to find support. How do we know if markets are anticipating growth and/or inflation? The prices of commodities such as WTI crude oil and copper are likely to rise. This information which markets communicate via price is subsequently likely to translate into the price action of CAD FX crosses, supporting CAD.

Most recently, commodity prices have fallen. This mostly coincided with the emergence of the coronavirus (currently known as 2019-nCoV), a recognized epidemic which has currently resulted in 24,631 confirmed cases, 494 deaths and 1,029 recoveries at the time of writing (source: John Hopkins University). Note that the "death rate" of almost exactly 2% can be found by dividing the number of deaths into the number of confirmed cases. There is however a likely lag effect, which could mean that the death rate could rise, however, the number of recoveries is growing far faster than the number of deaths.

It may be an optimistic tone to take, however, it is likely that the coronavirus is going to be effectively contained. Even if the number of confirmed cases continues to grow, so long as the growth rate remains non-exponential and global efforts to contain the virus continue, we should not see a spike in the number of international cases outside of the Hubei province in China (where the virus originated). The number of cases outside of Mainland China is currently only 212, as compared to the number of seasonal influenza cases which average an estimated 3 to 5 million cases of severe illness, resulting in 290,000 to 650,000 deaths (source: World Health Organization).

In short, as more information is received, and as we learn more about the coronavirus, it is possible (and perhaps probable) that markets begin to bid-up the price of risk assets (and commodities) like oil and copper. If we take the prior levels as starting points, we could see a significant boost (as the drop has already been steep for oil and copper); even a modest level of support would likely support the Canadian dollar.

It is also worth noting that the Bank of Canada, Canada's central bank, has one of the highest short-term interest rates globally at +1.75%.

This rate is technically even higher than the rate set by the U.S. Federal Reserve; while the U.S. maintains a target range which runs up to +1.75%, the lower limit of their target range is +1.50%, and hence the midpoint of +1.63% means that the Bank of Canada has the highest interest rate among all central banks of G10 nations (i.e., Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States).

(Source: Investing.com)

Most recently, it would appear that USD/CAD has approached a level which coincides with prior highs, yet the pair remains within a somewhat bearish trajectory (each turning point forming a lower high, since September 2019). The strength of the Canadian dollar over time should hold, provided that the Bank of Canada does not cut rates in its next meeting on March 4, 2020.

Yet a cut of 25 basis points would still only bring the rate to the lower end of the Federal Reserve's target range, and hence the Canadian dollar is typically likely to remain attractive against other currencies such as the euro, whose comparable rate is negative at -0.50% (this being the European Central Bank's deposit facility rate). From a carry-trade perspective, the Canadian dollar remains attractive. This would require a continued stabilization of oil prices though.

(Chart created by the author using TradingView. The same applies to all subsequent candlestick charts presented hereafter.)

Meanwhile, the EUR/CAD pair looks equally attractive as a short opportunity. The pair is trading lower most recently, and I have written more extensively on this pair recently (see article) in which I stated my belief that the pair would not only meet with its recent lows under the 1.45 level, but even see the 1.40 level over a longer time frame.

Together, the USD/CAD and EUR/CAD pairs would appear to be attractive short opportunities. A mixed exposure would probably be beneficial in this case, to eliminate the effects of fluctuations in the (tangential) EUR/USD pair.

Going "long CAD" is probably an optimist's trade at present. This author, while initially vigilant with respect to the coronavirus headlines, remains fundamentally optimistic. CAD crosses today appear to be perfect markets for expressing such optimism. Although the 50 handle on WTI crude oil will be important to watch (see chart below).

It is most probable that this 50.00 level will be retested in the near future, it being a key level just under the lows of June 2019, August 2019, October 2019, and also the level at which oil was able to settle initially in 2018 following a significant drop. However, provided that oil prices can sustain prices above the 50.00 mark, our bullish thesis on the Canadian dollar should remain intact.

Disclosure: I/we 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.