Canadian Dollar at Risk with Oil Losing Favor

The Canadian Dollar extended its pre-holiday rally this past week on the back of rising oil prices. OPEC leaving their production quotas unchanged initiated the support for crude with a large extended cold spell fueling the rally. Weak Canadian fundamental data has slowed the “loonie’s” appreciation against most currencies. The Ivey PMI reading for December fell more than expected to 48.4 against an estimate of 52.0, which was the first contraction in manufacturing in seven months. Meanwhile, the Canadian economy lost 2,600 jobs in December which significantly missed estimates of a 20,000 gain. The manufacturing sector led the decline which was a bit surprising despite the contraction in the sector because the employment component in the Ivey PMI reading rose to 49.2 from 42.6. This could be a sign that this month’s weakness is a minor setback in an otherwise strengthening labor market.

The prices paid component in the manufacturing gauge showed a decline in prices paid which is significant because if inflation continues to remain at bay then expect the Bank of Canada to remain committed to leaving rates unchanged until mid-2010. In fact if we continue to see “loonie” appreciation then the central bank may refrain from a rate hike for a longer period as it is their desire to limit the local dollar’s appreciation. Verbal intervention from Governor Carney has kept bulls cautious and led to the prior period of range bound price action. Although, physical action from the policy makers is unlikely as their track record is miserable at best but the mere threat could provide a layer of resistance.

The central bank is aiming to limit Canadian dollar appreciation in order to inspire demand for exports which lends importance to the upcoming industrial merchandise trade balance report. If we continue to see “loonie” bulls lose conviction a weak trade report could be a catalyst for a reversal. The report isn’t typically market moving and outside of it there isn’t any fundamental releases that have the potential to significantly impact price direction. Therefore, traders should continue to monitor crude prices as they are currently explaining 60% of USD/CAD volatility. The pair may look to test the 2009 low of 1.0205 before any significant reversal.