3 Reasons Supporting a Loonie Rebound

If there’s one currency that really took a hit when oil prices started sliding last year, it’s the Canadian dollar. As we’ve discussed in the School of Pipsology, Canada is one of the top oil producers in the world and is the largest supplier of oil to the United States, making its currency positively correlated to crude oil prices.

The Canadian currency has been lagging far behind its forex counterparts for the past few months, but recent economic developments suggest that the Loonie might soon be able to catch up. Here are some reasons supporting a potential rebound:

1. Recovery in oil prices

A quick look at the longer-term chart of Brent crude oil reveals that the commodity price may have already bottomed out:

After its steady tumble since the second half of 2014, oil prices have chalked up their longest streak of consecutive daily gains in quite a while. At the same time, USD/CAD seems to be stalling around its recent highs and may be gearing up for a longer-term selloff.

Reductions in oil supply have been responsible for shoring up the commodity so far this year, as tensions in the Middle East have weighed on production. U.S. oil rig counts have also been falling recently, which would mean fewer drilling activities and a potential decline in production.

2. Canadian economic figures aren’t all that bad

Canada isn’t exactly one of the better performing economies out there, but there are some green shoots in its latest reports. For one, the country’s manufacturing sales report for December capped off back-to-back monthly declines and posted a stronger than expected 1.7% rebound for the month.

The Canadian housing industry is also looking a bit brighter, with building permits and housing starts both beating expectations for December. Building permits surged 7.7% during the period while housing starts climbed from 180K to 187K, suggesting a likely increase in construction activity.

However, some reports still reflect weak spots and analysts fear that the worst of the oil price slump hasn’t been reflected in the latest figures yet. Note that the Ivey PMI, which is typically considered a leading indicator of economic performance, dropped from 55.4 to 45.4 in January and indicated industry contraction.

3. Monetary policy easing and risk appetite

The Bank of Canada’s surprise rate cut geared to pre-empt a much deeper inflationary rut might just do the trick in keeping the economy afloat. Recall that BOC Governor Poloz decided to lower rates from 1.00% to 0.75% last month in order to cushion the blows of the oil industry slump on other sectors of the economy.

Other central banks have also resorted to rate cuts or at least shifted to a more dovish stance in order to keep growth supported. With forex market participants starting to price in the idea of seeing these stimulus efforts translate to better lending and spending later on, risk appetite is starting to pick up once more and the higher-yielding Canadian dollar might be able to benefit from this.