USD/CAD: Loonie Slides to 2-1/2 Month Low on Omicron Fears; Downside Risks High

The Canadian dollar hit its lowest level in 2 1/2-month against its U.S. counterpart on Tuesday as investors worry that the new coronavirus variant Omicron will cause a broad sell-off in markets and further hamper the economic recovery.

“The loonie was a major victim of both the Friday risk sell-off and its exposure to oil prices and its overbought condition. Despite possibly having a more balanced positioning now, a hit to sentiment, oil prices and the potential pricing out of BoC rate expectations due to the Omicron variant spread, still signal sizeable downside risks for CAD,” noted Francesco Pesole, FX Strategist at ING.

Today, the USD/CAD pair rose to 1.2837 up from Monday’s close of 1.2738. The Canadian dollar hit its lowest level in over two months on Friday. After gaining about 2.3% last month, the Canadian dollar weakened by over 3.4% so far this month.

Canada is the world’s fourth-largest exporter of oil, which edged lower on Omicron and inflation worries. Oil prices hit over three-month low on Tuesday after Moderna’s chief questioned the effectiveness of COVID-19 vaccines against the Omicron, which shook the markets and raised concerns about oil demand, Reuters reported.

At the time of writing, U.S. West Texas Intermediate (WTI) crude was trading 46.30% lower at $65.53 a barrel. Lower oil prices lead to lower U.S. dollar earnings for Canadian exporters, resulting in a decreased value of the loonie.

“The 3 Commodity units (AUD, NZD and CAD) now appear vulnerable on 2 fronts – (1) as risk currencies trading in a risk-off environment created by the new Covid strain; and (2) the 3 units having one of the more aggressive central bank rate hike profiles discounted by markets. Against USD though, the 3 units could find better support (as USD is probably even more vulnerable to the removal of the more aggressive Fed rates pricing),” noted analysts at Citi.

On the other hand, the dollar index, which measures the value of the dollar against six foreign currencies, was trading 0.12% lower at 96.22 – not far from the 16-month high.

Last week, minutes of the U.S. Federal Reserve meeting confirmed market expectations that the Fed will raise rates sooner than other major central banks. The greenback rose to 16-month highs against most other major currencies because of the hottest U.S. inflation reading in a generation that pushed investors to bet that interest rates are likely to rise sooner than previously thought.

It is highly likely that the world’s dominant reserve currency, the USD, will rise by end of the year, largely due to the expectation of at least one rate hike next year. With the dollar strengthening and a possibility that the Federal Reserve will raise interest rates earlier than expected, the USD/CAD pair may experience a rise.

According to Statistics Canada, the Canadian economy grew 5.4% on an annualized basis in the third quarter, beating the market expectations 3.0% gain. October’s preliminary GDP rate was 0.8%, while September’s was in line with expectations.

“…the economy is running quite hot in Canada and a tight jobs market is fuelling concerns of persistent inflation. We’ll see whether the Omicron variant dramatically changes the economic outlook in Canada, which as of now, looks set to be a CAD-positive in the medium run. News on the variant will set the tone for global sentiment in the coming days and will drive all moves in CAD, likely out-shadowing any post-GDP reaction,” ING’s Pesole added.