It’s been an interesting – and volatile – few years of trading for the Canadian Dollar (CAD).
Between March 2020 and February 2021, CAD lost over 15% against the US Dollar as foreign exchange traders sought the “safe haven” of the greenback amidst the turbulence of the coronavirus pandemic. The Canadian dollar fell from 1.4366 against the US dollar to just 1.2076. However, with risk conditions gradually improving after the pandemic-induced disruption, it’s now trading close to March 2020 levels at 1.3678. Could 2023 see the Canadian Dollar trade above pre-pandemic levels and make strong gains against the US dollar? There are two main factors which Disruption Banking believes could drive CAD’s strength this year.
Interest Rates
Over the last three years or so, the main story on foreign exchange markets has been the strength of the US dollar. At the onset of the coronavirus pandemic, we saw a “flight to cash,” with traders seeking the safety of the greenback and other safe-haven currencies, such as the Japanese Yen. Then, the Federal Reserve became one of the first central banks in the world to move aggressively to tame inflation, which peaked at 9.1% in the States last year. Interest rates in America now stand at 4.75% and could rise further, while the Bank of Canada currently has rates slightly lower at 4.5%.
While, unlike other major currencies, CAD has managed to strengthen against the greenback despite this discrepancy in interest rates, this differential is likely to limit the Canadian Dollar’s upside potential. It seems unlikely that traders would shift en masse to the Canadian Dollar when they can gain better yields from holding the greenback, which is also considered to be one of the safest financial assets in the world. Particularly if the Fed moves to hike rates further – and Jerome Powell has suggested this could be a possibility – we could see renewed volatility on USD/CAD markets.
Oil Prices
Crude oil is Canada’s biggest export by far – with the country exporting around $11 billion of the commodity in December 2022 alone. This means there is naturally a strong correlation between the price of oil and the strength of the Canadian Dollar. Because oil is priced in US dollars on global markets, when the price is higher, Canada receives a higher influx of US dollars, which in turn strengthens the value of CAD relative to the greenback.
Crude oil prices are forecast to rise slightly in the first quarter of 2023 before flatlining throughout the rest of the year. The European Union has recently banned seaborne imports of Russian petroleum products and this could prove to have disruptive impacts on supply and therefore help to drive up prices. China’s reopening, and increased manufacturing in the country after three years of coronavirus-induced isolation, could also spur greater demand for the commodity. OPEC expects world oil demand to increase in 2023 will rise by 2.3% to 2.32 million barrels per day (bpd). That said, this could be threatened by the prospect of a global recession, which would reduce demand for oil and other commodities. Oil prices recently went down for this reason and this should serve as a warning for overly optimistic CAD forecasts:
Most analysts expect the Canadian Dollar to continue to perform weakly for the first few months of the year, before making sustained gains towards the end of the year. However, the picture could become more complicated if the Fed continues to make interest rate hikes and if global growth does not rebound as expected. Only time will tell if conditions will allow the Canadian Dollar to grow in strength throughout 2023.
Author: Harry Clynch
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