CAD: Guided by the oil prices - SocGen

Kit Juckes, Research Analyst at Societe Generale, explains that following the weakness in oil prices, a break lower for USD/CAD could see the major technical resistance at 1.3840 tested.

Key Quotes

 “Yesterday was the fifth time Brent prices have traded under USD 50/bbl in the last two months and the fifth time when the promptly bounced, though current spot at $50.24 isn’t exactly encoruraging. A clear break would sour sentiment significantly. In FX terms, the vulnerable currencies are NOK and CAD in G10, RUB and COP (much more than MXN of late) in EM. Short NOK/SEK seems a pretty good trade, just in case. As for USD/CAD, a break lower could see the major technical resistance at 1.3840 tested, and I don’t want to go short USD/CAD in blind hope that will hold. A break lower could see us go as far as 1.40, at which time valuation, both against the US dollar but also against AUD and NZD, is pretty irresistible.”

“In the very long run, currencies still tend to re-convergence with purchasing power parity (PPP), either because relative prices adjust or because the currency moves. The OECD estimates that the USD/CAD PPP exchange rate is around 1.24, quite a bit higher than my simple ‘latte’ index PPP index but also quite a bit below current levels.”

“CAD has tracked oil prices and relative yields in recent years and on oil prices, looks to have over-reacted to the most recent move. When USD/CAD was last above 1.37, Brent was USD 15/bbl cheaper. You can also track the under-performance of the CAD against PPP by looking at it relative to yield spreads. Higher breakeven oil prices for Canadian oil sands than for US shale have seen Canada suffer more than the US from low prices, and stress in the sub-prime mortgage market is hurting sentiment. As long as that translates into widening US/Canadian yield differentials, I’m loathe to dive into CAD longs. But the time to buy is approaching as the valuation gets stretched.”