Comment: Canadian dollar not yet over its troubles

The Canadian dollar depreciated to the lowest levels since December against the US dollar on Tuesday, with a possible trade war likely to do major damage, writes Ipek Ozkardeskaya of London Capital Group.

The negative trend is picking up momentum as the trade relationships with the US become tenser, oil remains cheap despite global efforts to sustain prices and the Federal Reserve shifts toward a more hawkish policy to stay up to speed with Donald Trump’s planned 'major' fiscal reforms.

US import duties will be a headache for Canadian exporters

As the US brings forward its fiscal reforms, the country’s leading trade partners are already suffering the consequences of the Trump rule.

Lately, the Trump administration announced that Canadian softwood imports to the US will be taxed at 24% versus the 3% up until now.

Canadian producers currently hold a third of the softwood market and generate roughly US$5bn each year. The eightfold increase in the tariffs will put a large part, if not the majority, of Canadian lumber businesses off the US market, given that the loss in the competitive advantage would be almost impossible to counterweigh by cost efficiencies or currency depreciation.

This could result in multi-billion-dollar gap in the Canadian export revenues from the softwood lumber only.

If we extend the similar risks to Canada’s entire export market, the picture gets naturally more troubling.

In 2016, exports to the US represented 78% of Canada’s total exports.

If a trade war between the two trade partners flares up any more, both countries will come out with significant damage in the medium to long-term.

Yet the Canada would be hit harder, as only 22% of the US exporters would be subject to a similar reaction from the Canadian government.

Cheap oil weighs on the Loonie

There is a very close relationship between the Canadian dollar - known as the Loonie - and the price of oil.

The 20-day trailing correlation between the price of West Texas Intermediate crude and the value of the Canadian dollar in US dollar terms can reach 80%, especially in times of the bearish conditions in the oil markets.

Recently, the recovery in oil prices faltered despite OPEC’s efforts to reduce the global supply glut.

Oil output from the US poses a major caveat to diminishing the global inventories, given Donald Trump’s will to decrease the US’ international energy dependency. US oil inventories reached an all-time high in March and the uptrend is unlikely to reverse.

According to the latest EIA report, global oil inventories increased in the first quarter of the 2017.

As a result, we are not sure that a global crude price recovery toward the $60/70 range would be possible any time soon.

Current low market prices hold Canadian producers back from their costly oil sands projects, which are estimated to reach the breakeven from $80 a barrel on average.

Divergence between the Fed and the BoC

Trump’s tax reforms are not possible without consequences on the US dollar.

The Federal Reserve is inevitably alert in keeping US monetary policy from contributing to overheating in the US economy as a result of Donald Trump’s extensive fiscal plans, including significant tax cuts on private and corporate levels, as well as significant spending on infrastructure.

The Fed may feel forced to steepen its interest rate normalisation policy along with its portfolio shrinkage plans.

Across the border, the Bank of Canada (BoC) is expected to maintain the rates unchanged at 0.50% at least until April 2018. During this time, the Fed is expected to proceed with 150 basis points increases or more.

The divergence between the Fed and the BoC’s future policy outlooks will unavoidably weigh on the Loonie against the greenback.

In the short-run, the stronger positive trend in USD/CAD suggests renewed pressures on 1.3575, the Fibonacci 50% level on 2016 decline, before the 1.40 hurdle.

Whether the short-term uptrend could extend beyond this level will depend on developments in the US, the speed of deterioration in the mutual trade relationships, as well as the global oil and commodity prices.

The USD/CAD pair is expected appreciate toward the 1.43-1.45 over the next 12-month period.

Ipek Ozkardeskaya is a senior market analyst at London Capital Group