After nearly righting itself after a volatile week, the Canadian dollar gets hammered

By mid-week things weren’t rosy, but the Canadian dollar had edged higher against its U.S. counterpart on Wednesday, with the currency rebounding from an earlier one-week low as oil prices rose and the Federal Reserve hiked interest rates, as expected, for a second time this year.

The price of oil, one of Canada’s major exports, turned positive after a bigger-than-expected decline in U.S. crude inventories along with surprise drawdowns in gasoline and distillates indicated strong demand in the world’s top oil consumer.

U.S. crude oil futures settled 0.4 percent higher at $66.64 a barrel.

Federal Reserve officials saw the likelihood of two more interest rate increases for a total of four in 2018 based on a solid economic outlook.

“There was a lot of volatility in the markets with the Fed announcement,” said Rahim Madhavji, President at Knightsbridge Foreign Exchange. “The Canadian dollar went for a bit of a ride.”

Then, as of late yesterday and trending poorly throughout the night and into today, the short-lived support fell. The European Central Bank (ECB) announced that key interest rates were going to remain unchanged until the summer of 2019. This came as a negative surprise, according to Madhavji. The Fed was predicting a faster pace to U.S. hikes.

U.S. tariffs on Canadian steel and aluminum imports come amid slow-moving talks between Canada, the United States and Mexico to modernize the North American Free Trade Agreement (NAFTA). Canada sends about 75 percent of its exports to the United States, so its economy could be hurt if NAFTA were scrapped.

As you can see in today’s BNN Bloomberg graph analysis of the Canadian dollar’s past year, the value of the Canadian dollar has declined by approximately 12 percent, relative to that of the US dollar.

At the same time, the price of oil has fallen by roughly 48 percent. The correlation between the two variables—the Canadian dollar-US dollar exchange rate, and oil prices—is high and has existed for a long time. The high correlation, and the extent to which the value of the Canadian dollar is tied to the US dollar, can be directly attributed to the way Canada earns US dollars, and the percentage of Canada’s revenue that this constitutes.

While oil is by far the strongest correlation, it’s not the only strongly tied aspect of the U.S. and Canadian economies. According to Investopedia, over the last 6 years, crude oil has been the largest component of goods exported. Goods exported has accounted for over 72 percent of current account receipts earned by Canada. The top 5 categories of goods exported have contributed over 66 percent of the total goods exported and over 46 percent of current account receipts.

These 5 categories of goods are ‘Mineral Fuels’, ‘Vehicles & Aircrafts’, ‘Machinery, Electrical Equipment, Parts etc’, ‘Base Metals’, and ‘Products of Chemical or Allied Industries’ (see figure 2). Of the top 5 goods, ‘Mineral fuels’—energy-based exports—is the largest foreign exchange earner. Crude oil accounts for over 60 percent of foreign exchange earned from ‘Mineral Fuels’, and it is also larger than the second, third, fourth and fifth largest category of goods exported.

On top of everything else, the Canadian dollar is also vulnerable to the fallout from the U.S. and China’s trade dispute from shifts in risk aversion trading.

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