USD/CAD: Zoning in on Parity

The Canadian dollar has been on a tear. In the past six months, the currency has made new 30 year highs after appreciating over 12 percent against the US dollar, putting parity within reach. At the beginning of the year, an exchange rate of 1.0 for USD/CAD seemed like a far fetched target, but now it has become a realistic and very probable one. Even though sentiment has become very one-sided and technicals indicate that the currency pair is extremely oversold, there is no major support until parity. With the risk of a global slowdown, record high oil prices and a resilient economy is behind the strength of the Loonie.

The Impact of a US Slowdown
The latest move in the Canadian dollar has befuddled many investors because the Canadian economy has traditionally been very sensitive to US economic growth. It is estimated that Canada exports 80 percent of their goods to the US, which makes it logical to assume that a slowdown in US demand would translate into a slowdown in Canadian exports. However over the past few years, Canada has become less reliant on US demand as the country’s vast oil resources begin to attract the attention of resource hungry countries like China.
Since Canada discovered a new source of oil after the reclassification of their Alberta oil sands to the economically recoverable category, their geopolitically turmoil free status has made them a very attractive provider of oil. Also, over the next 3 years, China’s oil import needs are expected to double and match that of the US by 2030. With little oil resources of their own, China has become a major buyer of oil on the global markets. This has helped the Canadian economy become more immune to the economic stability which may be part of the reason why Canadian data has been consistently surprising to the upside while US economic data has seen nothing but back to back disappointments. In the month of August, when the subprime crisis began to unfold, IVEY PMI actually jumped from 54.6 to 58.5, indicating increased manufacturing activity. During the same month the US lost 4k jobs while Canada added 23.3k. Manufacturing shipments continue to remain strong while net foreign purchases of Canadian securities increased for the first time in 3 months. This will keep the Bank of Canada on hold for the remainder of the year, which comes in stark contrast to the US Federal Reserve who is expected to lower interest rates by as much as 75bp this year.
Canada Benefits from Prospect of $100 Oil
Trading USD/CAD these days has become synonymous with trading oil. The fate of oil and USD/CAD are intermingled because the Canada is the world’s second largest holder of oil reserves and the US’ most significant oil supplier. Unbeknownst to many, the size of their oil reserves is second only to Saudi Arabia. The geographical proximity between the US and Canada as well as the growing political uncertainty in the Middle East, Africa and South America makes Canada the preferred importer of oil to the US. Canada also remains one of the few places where multinational firms can access strategically important oil reserves. As indicated by the chart below, this correlation has lasted for years.

Therefore the speculation that USD/CAD will fall to parity is implicitly the same as expecting oil prices to rise to $100 a barrel. With crude climbing back above $80 a barrel to hit an intraday high of $80.70 today, that is not inconceivable notion. Despite the problems in the US economy, fears of hurricanes, attacks on Mexican oil facilities, a lower than expected production increase by OPEC and the continual rise in global demand is driving oil prices to new highs. Many economists expect oil prices to reach as high as $100 a barrel by the end of next year as China and India become more modernized, leading to an increase demand for energy resources.
Technically, with USD/CAD making lower lows and lower highs, there is no reason to believe that this downtrend will end until we get a break and close back above 1.04.

Written by Kathy Lien, Chief Currency Strategist of