The crude oil crash and partial recovery has had a profound impact in trading in Canadian markets (CAD pairs and Canadian stocks) over the last year. While the initial impact of the oil price drop on the Canadian economy was negative, leading to a loss of employment, particularly in the oil patch. Along with the drop with oil prices, CAD also declined, which has cushioned the longer impact, helping Canadian manufacturers and exporters to rebalance the economy. Back In January, when nobody knew how low oil could go or how long it could stay down, the Bank of Canada cut its benchmark interest rate to 0.75% from 1.00%. This moved followed that of Norway’s Norges Bank, another oil producer, who moved in December of 2014. Through the spring, Bank of Canada meeting statements and other public pronouncements have been consistently calling the January rate cut an insurance policy and indicating a one and done approach to monetary easing. In June of 2015, however, Norges Bank cut interest rates again and suggested that it could cut interest rates even further this fall. This has reopened the discussion of whether or not the Bank of Canada could cut interest rates as well this summer? Bank of Canada meetings are scheduled for July 15th and September 9th Factors that may influence Canadian interest rate trendsCanadian Economic Reports The table below shows that the oil price crash did have a negative impact on Canada’s economy but also that the worst of the storm may have passed. There were significant job losses in January and March, but jobs have rebounded in April and May. Unless full time employment turns lower again, there’s no reason for the Bank to cut again to stimulate employment. Similarly, headline inflation dropped off between October and April but started to turn upward in May, while core inflation has remained above 2.0%. Throughout this period, Canadian headline inflation has remained well above that of many other G-7 countries. So the Bank of Canada to cut interest rates again to fight deflation, and there is a good possibility that it may eventually need to raise interest rates to keep a lid on inflation pressures. Retail sales has been more mixed. It was a rough winter at the malls with sales down sharply in January and February, but sales had rebounded into the spring. The most recent month declined again, suggesting the recovery may be sputtering out. Current data suggests that there’s no need for another rate cut this summer, unless retail sales were to weaken dramatically and employment was to take a sharp turn south as well.
|Canada Key Economic Indicators|
Source: CMC Markets CAD and the Oil Price It’s important for traders to remember that big increases in the level of the Canadian Dollar can do a lot of the Bank of Canada’s work for it. When the loonie falls, it makes exports cheaper and imports more expensive, and makes Canada a cheaper vacation and shopping destination relative to the United States. The opposite occurs when the loonie rises. The drop in the value of CAD earlier this year has done some of the Bank of Canada’s stimulus work for it already. The chart below, meanwhile shows that the street is not expecting another cut in Canada any time soon. Although the currencies of big oil exporters like CAD, NOK and MXN have declined in tandem with oil prices over the last year, currencies have not fallen nearly as much as commodity prices. Interestingly, CAD down about 12% over year, has fallen less than MXN down about 15% and NOK down about 20%. NOK may be responding more to its proximity of the troubled Eurozone as its main customer while Canada and Mexico primarily export to the relatively stronger United States. The outperformance of CAD relative to NOK also suggests that traders expect the Bank of Canada to remain neutral and thus hawkish relative to the dovish Norges Bank. Source: CMC Markets The rebound in the price of oil and its future trend may also influence Bank of Canada decisions. When the Bank cut interest rates on January 21st. WTI was trading at $47.78. Since then, crude has recovered somewhat and WTI has rallied 24% to a recent price near $60.00. The Oil Price Outlook and Drilling Activity Part of the reason that the oil price rebounded in recent months has been on speculation that slowing exploration activity in the US and Canada would lead to lower production and reduce oversupply. The only problem with this line of thinking is that OPEC countries, particularly Saudi Arabia and Iraq have stepped up production and taken away market share from US shale producers, so the supply war problem hasn’t gone away and could get worse if a nuclear deal gets done and Iran returns to the market (which could happen this summer). Because of this, the upside for oil appears limited, perhaps to $65 or $70 for WTI. Meanwhile, reduced exploration and production limits the downside for the oil price as well. The table below shows that there are seasonal fluctuations in oilfield activity, particularly in Canada. Although we are past the seasonally weak parts, and exploration may continue to pick up a bit as it has in Canada, drilling activity remains well below last year’s pace and its 5 year average.
|Drill Rig Count Seasonality|
|June 2015 data up to June 19th|
Source: Baker Hughes, Bloomberg L.P., CMC Markets Conclusion: So far, the Bank of Canada’s decision to make an early rate cut for insurance when oil fell appears to have paid off, helping to stabilize the economy until the benefits of the lower loonie could kick in. Between the higher oil price, increasing employment and rebounding inflation, there doesn’t appear to be any reason for the Bank of Canada to cut rates any further for now. It would probably take a drop back into the low $40s toward a retest of its winter lows to get the Bank to reconsider its current neutral stance.