USD/CAD: Loonie Falls on Weak Oil Prices; Outlook Remains Bleak

The Canadian dollar traded marginally lower against the U.S. counterpart as the firm greenback and falling energy prices weighed on the commodity currency.

Today, the dollar to loonie conversion rose to 1.2526, up from Wednesday’s close of 1.2506. The Canadian dollar had lost about 1% in July – the second biggest monthly drop since September 2020 and has weakened about 0.3% so far this month.

Canada is the world’s fourth-largest exporter of oil, which edged lower on rising concern that the new delta variant will derail the global economic recovery, slowing the recovery of oil demand.

U.S. West Texas Intermediate (WTI) crude futures were trading 0.10% lower at $69.18 a barrel. Lower oil prices lead to lower U.S. dollar earnings for Canadian exporters, resulting in a decreased value of the loonie.

“The greenback continues to be guided by market-perceived global economic risks (and associated capital flows), strengthening when they rise but weakening when they fall. And, amid the surging Delta variant, it has been more of the former instead of the latter. It’s currently about 2½% above the pandemic low hit at the beginning of June. However, we judge the greenback will ultimately re-weaken again, once the market gets over the Delta blues, averaging around 1½% lower by 2021-end and a further 1¼% by 2022-end—once again testing the pandemic low,” noted Michael Gregory, an economist at BMO.

“This should help the loonie change its recent flight path. It has been weakening in the wake of U.S. dollar strength, dropping under US$0.785 (above C$1.274) mid-last month, from highs above $0.830 (below C$1.205) at the start of June. A relatively more hawkish Bank of Canada (vs. the Fed) should help as well. We see the Canadian dollar eventually appreciating to around US$0.816 (C$1.225) by the end of this year and US$0.833 (C$1.200) by the end of next year.”

The dollar index, a measurement of the dollar’s value relative to six foreign currencies, was trading 0.08% higher at 92.996 – not far from this year’s high of 93.437.

The greenback was supported by hawkish remarks from the US Federal Reserve which led markets to move forward with expectations of policy tightening. The Federal Reserve may move forward on tapering asset purchases and increase rates sooner if the inflation rate rises. This could effectively push the dollar up in value.

The risk that the world’s dominant reserve currency, the USD, rise over the coming year is high, largely driven by the Fed’s expectation of two rate hikes in 2023. A strengthening dollar and growing risk that the Federal Reserve would tighten its monetary policy earlier than expected would push the USD to CAD pair higher.