Oil and the Canadian Dollar have a well known relationship. When Oil goes up, so does the Canadian Dollar.
This correlation has been estimated to be extremely high during some time periods. The FXC shows this relationship very well, as does the USDCAD.
Still, this correlation can change in strength - sometimes the Canadian Dollar does not respond as much to oil prices changes as in other times. When oil gets above roughly $95 USD per barrel, the strong fundamental reason for a link between the Canadian Dollar and oil gets muddy.
It’s simple to see why the Canadian Dollar should be linked to the price of oil. Canada supplies more oil to the United States than any other country. Here’s a chart from the EIA showing just how much oil Canada pipes into the U.S.
(click to enlarge)
All this oil is paid for in dollars, but some huge amount of those dollars will get exchanged into Canadian Dollars. So as oil shifts in price, the Canadian dollar will too.
This dynamic gets more complicated when the price of oil gets above 90 USD a barrel. At this price, oil and gasoline costs begin to cause a significant drag on the U.S. economy. I believe higher gasoline prices have significantly reduced growth in the U.S. over the last several years.
It’s estimated every $.01 increase in the price of gasoline takes $1.4bn out of the U.S. economy. Gasoline going from $3.00/gallon to $4.00/gallon takes $140bn out of the U.S – or about 1% of GDP!
When prices are above $90 USD per barrel, the risk of a recession in the U.S. is significantly higher than when oil prices are lower than $90. And Canada’s entire economy is dependent on exporting to the U.S.
Higher oil prices present a dilemma for the Canadian Dollar. Are the higher oil prices good for Canada just from oil money flows? Or will the higher oil prices cause a recession in the U.S. and push Canada into a recession too?
So as oil gets “too strong” – and that’s widely viewed to be over 90 to 95 USD per barrel, the link between upward movement in oil prices and upward movement in the Canadian dollar should weaken.
As oil gets below 90-95 USD per barrel, the relationship between oil prices and the Canadian dollar will reassert its traditional strength.
With oil prices seemingly in free fall, this could have a significant impact on the USDCAD currency pair over the next several weeks.
Related posts:
- Generate FX Signals 3-28-2012: Short Australian Dollar
- Is the U.S. Dollar in trouble? You can’t tell from looking at the U.S. Dollar index
- Revenge of the U.S. Dollar: TF 101 Signals 3-14-2012
- Generate FX Signals 4-4-2012: The Australian Dollar breaks lower
- Australian Dollar blowing out due to Carry Trade Unwind
Michael Sankowski spends a lot of his time applying quantitative mathematics to financial markets. When he's not playing the guitar, he has been a professional trader for 20 years. He's traded billions of dollars on four continents and is a well-known financial writer. He's a CFA, CAIA, and has created patented Futures products. He's here to help you make more money (and especially not lose your money).
