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Foreign Exchange

Declining oil prices to steal CAD’s crown as commodity currency king

The lacklustre macroeconomic outlook and elevated oil-supply levels point to a continued fall in crude prices and a further blow to the G10’s most oil-sensitive currency, the Canadian dollar.

Brent crude oil prices, at $106 per barrel, are now down more than $15 from their highs in March. In May alone, prices have fallen 10%, as a weakening global growth picture triggered a sell-off in crude. “The path of least resistance for oil is lower, particularly with bearish catalysts continuing to emerge,” says Hussein Allidina, global head of commodities strategy at Morgan Stanley.

Fragile macroeconomic conditions, easing political tensions in the Middle East and bearish fundamentals all point to continued weakness in crude prices.

Refining margins have narrowed with refiners starting to exit maintenance, indicating weak product demand, explains Allidina.

With this in mind, OPEC has also been vocal about its desire to see oil prices at $100 a barrel, suggesting production levels are likely to remain elevated until prices fall.

Morgan Stanley estimates that, at current production, oil supply will continue to exceed demand by as much as 800,000 barrels per day.

From an FX perspective, how then should investors best gauge the currency impact of a change in oil prices?

Most important is whether the country is a net exporter of oil and how large those trade flows are, relative to the economy. Other factors that affect the FX impact of an oil price shift are the sensitivity of consumer prices to oil, the economy’s gearing to global growth, and the size of external funding needs, explains Gabriel de Kock, head of Morgan Stanley FX strategy in New York.

Looking at net oil exports as a percentage GDP, Morgan Stanley shows that the Russian rouble, Norwegian krone, Malaysian ringgit and Canadian dollar are most exposed to a fall in oil prices. At the other end of the scale, the Indian rupee, Thai baht and Korean won would be the biggest beneficiaries.

 
 Source: Morgan Stanley

“In the G10 space, taking all factors into account, the Canadian dollar is by far the most oil-sensitive currency,” says De Kock. Although Norway exports more oil, it leaves most of its revenues offshore, muting the impact of oil-price shocks on the currency.

While the Canadian dollar has, in many ways, become the commodity currency of choice – given AUD’s vulnerability to a slowdown in China – CAD’s exposure to oil prices will firmly put the brakes on further demand.

Taking positioning into account, the CFTC data show that the net long position in the Canadian dollar recently reached multi-month highs, overtaking the Australian dollar. A retracement of the build up in CAD longs might accelerate if oil prices continue to move lower.

Commodities dominate Canada’s exports and, as a result, the Bank of Canada’s commodity price index is the best predictor of medium-term trends in the CAD.

 
Source: Morgan Stanley

“Oil is by far the most important of Canada’s exports, making up more than 40% of commodity exports,” says De Kock. “A further $10 decline in the oil price, consistent with bank’s forecasts, would signal significant downside risk to the Canadian dollar, as much as 6%.”

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