I. Bank of Canada (BOC) Monetary Policy
The BOC’s mandate is to keep inflation between 1-3% as a means of providing a stable price environment over the medium term. It sees a flexible exchange rate as instrumental in being able to achieve this, while also providing a “buffer” against internal and external economic shocks.
The central bank can use conventional policy instruments such as interest rate hikes and cuts as well as open market operations (among other monetary levers) to achieve its target. The BOC can also use non-standard policies such as Quantitative Easing (QE) that emerged after the 2008 global financial crisis and follow-on Great Recession.
The central bank also holds press conferences where markets can approximate the direction of interest rate hikes or cuts based on hawkish or dovish rhetoric from BOC officials. Additionally, indicators of economic activity such as GDP and CPI reports, along with PMI surveys, can have a noteworthy effect on the Canadian Dollar.
Unexpectedly positive or negative data from these various releases has a tendency to lead markets to speculate on potential hawkish or dovish shifts in BOC policy. Consequently, this speculation often leads to price fluctuations in the Canadian Dollar.
II. Market Sentiment
Canada is a major exporter of key natural resources, such as agricultural products, crude oil, lumber, and natural gas. That puts the country at the relative beginning of the global supply chain, which can make it especially sensitive to changes in the outlook for worldwide economic activity. In practice, this can mean the currency echoes swings in market-wide risk appetite, as reflected in benchmark stock indexes like the S&P 500.
Furthermore, Canada is the fourth largest supplier of petroleum in the world. To the extent that large swings in crude oil prices are seen as likely to influence Canada’s economic fortunes and influence BOC policy, such moves can be echoed in the currency.
III. Relationship with the United States
The US accounts for nearly 80 percent of Canadian exports. This means that changes in relations with the country’s southern neighbor can stoke substantial exchange rate volatility. For example, a 2017-18 push to renegotiate the seminal NAFTA free trade agreement by US President Donald Trump turned contentious, stoking uncertainty and weighing heavily on the currency.
Effect of metal tariffs on the CAD
REASONS WHY USD/CAD AND OIL PRICES MOVE TOGETHER:
The reasons for the USD/CAD crude oil correlation include Canada’s status as leading oil exporter, supply and demand considerations, and the revenues in USD that Canada enjoys as a result of its exporting activity.
Canada is an important net exporter of oil
Canada is the fourth largest exporter of crude oil in the world, according to 2018 figures. Due to the country’s status as a net exporter of oil, its currency in relation to USD is highly correlated to oil prices. oil.
Supply and demand:
Supply and demand is also a key influencer of the correlation between crude oil and USD/CAD and relates to the demand and supply of both Canadian dollars and US dollars. Exports of crude oil account for a large percentage of US currency earned by Canada, meaning shifts in the volume and price of crude oil have a significant impact on the flow of US dollars into the Canadian economy.
High crude oil prices also mean higher USD earnings for Canada on its exports, meaning a strong supply of US dollars flowing into Canada, resulting in an increase in the value of the Canadian dollar.
Conversely, when the price of crude oil is low, the supply of USD will be low relative to that of the Canadian dollar, resulting in a decrease in the value of the Canadian dollar.
TRADING THE CANADIAN DOLLAR
The Canadian Dollar is the seventh-most traded currency in the world, composing 5.1% of global market turnover (according to the Bank of International Settlements). USD/CAD – the Canadian Dollar’s pairing with the US Dollar – is the sixth most traded currency cross globally. This speaks to relatively abundant liquidity, which often implies comparatively lower transaction costs and higher-quality trade execution.
Canada’s close economic relations with the US means that traders can use the Canadian Dollar as a vehicle to gain indirect exposure to key developments in the world’s largest economy. It can sometimes also offer a gateway to the oil market, although such correlations wax and wane over time and do not imply a causal relationship between currency and commodity prices.
Commonly traded CAD currency pairs:
(Courtesy of dailyfx)