Morning Commentary: Cruel Crude

Foreign Exchange - Morning Commentary
Cruel Crude  
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
On a year to date basis, commodity currencies have underperformed in the G10 space.  However, within the commodity currency group, the Canadian dollar has been a relative outperformer even with a sharp drop in oil prices.  Despite this performance thus far, there are reasons to believe that the Canadian dollar will underperform moving forward. 

Even before the current crisis, Canada had one of the worst balance of payment positions (BoP) in the DM with its current account and FDI deficit nearly double that of its closest peer.  This becomes even more of a concern when you consider that “currencies and deposits” was a key category seeing inflows.  If 2019’s surge in cash inflow was driven by Canada’s position as a high yielder, the subsequent collapse in Canadian yields puts cash inflows into deposits at risk and throws a big question mark around an important source of external financing.   

Further, Canada’s position as a high cost of producer of oil makes it more vulnerable than other oil producers.  The current oil price war is being fought in order to balance out long term global supply.  Canada’s high cost of production means that its producers should be among the first tranche of producers that have to consider shutting down.    

This means that low oil prices are not simply an issue of unprofitability but also of outright shutdowns.  To this point, some producers have already shutdown production which risks long term damage to the oil sand’s future value.  With energy extraction accounting for nearly 20% of Canadian goods production, it will have a material impact on the Canadian economy.  This is especially poignant when you consider than Canada lacks an idiosyncratic offsetting factor such as Norway’s sovereign wealth fund.  

USDCAD has rebounded off its lows, but oil prices remain depressed.  This suggests that CAD has room to adjust down to the level of oil as crude remains a long term anchor for the currency.  Finally, negative dynamics in the oil sector should also exacerbate BoP issues.  Oil accounts for 80% of Canadian exports.  Any reduction in trade will hit an important factor keeping the current account deficit from being worse than it is. 
  • The US House of Representatives passed the $484 billion virus support package yesterday and President Trump is expected to sign it into law today.   As part of this package, the PPP program has received additional funding.  Attention now turns to the next support package for which negotiations are expected to be even more contentious. 
  • Yesterday’s meeting between European leaders ended without an agreement on the European Recovery Fund.  Europe’s inability to unite behind a strong fiscal response is one of the key reasons why the US economy and the US dollar should outperform the European economy and the euro.   
  • The most recent round of Brexit talks will conclude today and is set to resume early May.  The EU’s Chief Negotiator is scheduled to hold a press conference today to summarize progress with someone from the UK side to do the same.  The expectation remains for both sides to remain far apart.  News reports also indicate that UK PM Johnson will return to work as early as Monday.
  • Yesterday’s miserable PMI numbers have been followed up by further bad economic data illustrating the hit to economic activity.  German business confidence has dropped to an all-time low and UK retail sales for March suffered its biggest fall ever. 
  • Virus news continues to be mixed.  Germany saw its largest jump in new infections in a week with Russia also reporting an increase in cases.  Conversely, Spain reported its lowest number of deaths in ~5 weeks.  Further complicating the outlook were reports that Gilead’s trial of its COVID-19 drug was a failure.  Gilead’s drug, remdesivir, is one of the most closely-watched therapies of the dozens being developed and tested as potential treatments for COVID-19 patients.
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