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As you can see below, the Loonie is closing out the year on a mixed note as of December 22.

And while the Loonie’s price action did become a bit more mixed near the end of the year, most CAD pairs actually had three distinct phases, so the Loonie wasn’t just a mere victim of opposing currency price action.

Overlay of CAD Pairs: Daily Chart
Overlay of CAD Pairs: Daily Chart

As to what drove the Loonie’s price action, they can be simplified and classified into two categories:

  1. Oil
  2. The BOC’s monetary policy & forward guidance

1. Oil & CAD

USD/CAD (inverted) & Crude Oil: Daily Chart
USD/CAD (inverted) & Crude Oil: Daily Chart

As always, Loonie pairs took directional cues from oil prices. And if you’re a newbie and have no idea why CAD and oil are positively correlated, then you may wanna check out our School’s lesson on How Oil Moves with USD/CAD.

Anyhow, oil started 2017 on the back foot. There were many factors in play, but as noted in an earlier write-up, the major reasons that were often cited include:

  1. the threat of higher U.S. oil output because of the steady increase in U.S. oil rigs
  2. concerns that OPEC won’t extend its 2016 oil cut deal in order to offset the additional supply from U.S. oil rigs

To these I would add the possibility of profit-taking by oil bulls. After all, Oil Had a Great Year in 2016 (And So Did The Loonie).

Oil did see bursts of bullishness during the early slide, which was linked largely to speculation on an OPEC oil cut deal extension. However, selling pressure ultimately prevailed.

And when OPEC did announce an extension to its oil cut deal on May 25, oil encountered selling pressure instead of rallying because OPEC failed to surprise the market by announcing only a simple nine-month extension to its oil cut deal, which was within expectations. Also, Nigeria and Libya were given a pass and the latter, in particular, had plans to ramp up its oil output levels.

Oil began to find support in late June, however, and it soon became apparent that oil was trending higher. And oil’s uptrend was attributed mostly to easing concerns on the oil glut, thanks to falling U.S. oil inventories.

There were other drivers as well, of course, such as the year-on-year increase in Chinese oil imports and the Keystone pipeline oil leak in November. Also, there was speculation that OPEC may announce another extension to its oil cut deal to help the oil market rebalance faster.

And OPEC did announce on November 29 that it will further extend its oil cut deal until the end of 2018, with the caveat that the deal may be nullified earlier if the oil market is judged to have balanced out already or is showing signs of overheating.

Simple enough, right? But as marked below, there were periods when the Loonie’s price action diverged from oil prices.

USD/CAD (inverted) & Crude Oil: Daily Chart
USD/CAD (inverted) & Crude Oil: Daily Chart

This goes to show that oil wasn’t the only driver of the Loonie’s price action. And the other major driver for the Loonie’s price action happens to be…

2. The BOC’s Monetary Policy & Forward Guidance

USD/CAD (inverted) & Crude Oil: Daily Chart
USD/CAD (inverted) & Crude Oil: Daily Chart

The Loonie felt the BOC’s influence early on when the BOC communicated that it retained its easing bias when BOC Governor Poloz bluntly said the following during the January BOC statement:

“[W]ith inflation having been below target for a prolonged period, yes, a rate cut remains on the table and it would remain on the table for as long as downside risks are still present”

Canada’s economy was doing well enough at the time, so there were expectations that the BOC would sound more hawkish. Instead, the BOC retained its easing bias, which is rather disappointing and caused the Loonie to tank even as oil prices tilted slightly to the upside.

The BOC then retained its dovish tone during the March BOC statement. The Loonie didn’t really react strongly, however, and most Loonie pairs were taking directional cues mainly from falling oil prices.

Anyhow, the BOC dampened demand for the Loonie yet again at the start of the April when the BOC released its Spring Business Outlook Survey since the BOC said the following in the report.

“Firms anticipate little momentum in input and output prices because of still-important competitive pressures. Inflation expectations remain concentrated in the lower half of the Bank’s inflation-control range, although they have edged up marginally.”

This dovish view on inflation reinforced the idea that the BOC isn’t expecting inflation to pick up the pace, which means that the BOC ain’t gonna be hiking soon. And this apparently caused the Loonie to trade mostly sideways even as oil prices recovered because of Trump’s missile strike in Syria.

The BOC would finally remove its easing bias during the April BOC Statement when Poloz said the following:

“[G]iven the data that we’ve seen in the last few months, I can quite clearly say no, a rate cut was not on the table at this time.”

However, the Loonie didn’t get a break and was dragged down by sliding oil prices, likely because Poloz highlighted a potential problem in Canada’s housing market when he said the following:

“[W]hen there is that large of a gap between what fundamentals might say and what you actually observe, then there is very unlikely to be a sustainable rate of price increase and I think it is timely to remind folks that prices of houses can go down as well as up.”

Canada’s housing market didn’t really deteriorate all that much, though. In fact, Canada’s economy continued to meet or exceed the BOC’s expectations, so much so that BOC Senior Deputy Governor Carolyn Wilkins gave the earliest hint of a switch to a hiking bias when she said in her June 12 speech that:

“As growth continues and, ideally, broadens further, Governing Council will be assessing whether all of the considerable monetary policy stimulus presently in place is still required.”

BOC Governor Poloz was in a radio interview the following day (June 13). And while he sounded a tad more cautious than Wilkins, he nevertheless supported her hawkish message when he said that:

“What that [the data] suggests to us is that the interest rate cuts we put in place in 2015 have largely done their work.”

And that’s all that Loonie bulls needed to hear to push the Loonie higher, causing Loonie pairs to decouple from oil prices, which were still in decline at the time.

Well, short-covering by Loonie bears would probably be more accurate since the COT report shows that Loonie bears started unwinding their short bets on CAD futures in June. Also, large speculators didn’t really start adding to their long positions until July, after the BOC already hiked.

Source: COT Report from the CFTC
Source: COT Report from the CFTC

Speaking of the July rate hike, Canada’s economy continued to meet or beat the BOC’s expectations, so much so that the BOC hiked rates for the first time in almost a decade during the July BOC statement and then followed this up with another hike during the September BOC statement.

The BOC’s tune began to change, however. And it all started when BOC Deputy Governor Timothy Lane said in a September 18 speech that the BOC is keeping an eye on the Loonie’s strength:

“[F]or much of the past decade, a strong Canadian dollar—battered many of our export industries and splintered their supply chains.”

Now as the Canadian dollar is strengthening, we’re certainly watching that closely and we’ll be taking that into account pretty strongly in making our decisions.”

BOC Governor Poloz revealed a couple of weeks later that he shared Lane’s thinking when Poloz said in his September 27 speech that:

The temporary factors that have been holding inflation down should dissipate in the months ahead, although recent exchange rate developments could affect this timing.”

“Among the financial market developments that we watch closely are movements in longer-term interest rates and the exchange rate.”

To make matters worse, Canada’s September CPI and August retail sales reports were both disappointing. And since they were released on October 20, a few days ahead of the October 25 BOC statement, they caused the Loonie to react negatively.

And when the BOC did finally announce its October monetary policy decision, the Loonie encountered more selling pressure because the BOC’s outlook was rather cautious.

Moreover, the BOC officially announced that it switched to a more neutral monetary policy bias (but with a long-term hiking bias) when Poloz said the following (emphasis mine):

There’s nothing automatic, no predetermined path for interest rates, only a clear assessment that yes, over time, if the economy continues to behave as it has less monetary stimulus will be needed because the economy will be getting very close to home.”

Hopes that the BOC may sound hawkish got revived when Canada’s jobs and GDP reports both surprised to the upside on December 1.

Sadly, for rate hike junkies, the BOC just shrugged off the recent positive economic developments in Canada and gave this killjoy of a forward guidance during the December BOC statement (emphasis mine).

“While higher interest rates will likely be required over time, Governing Council will continue to be cautious, guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation.”

Do note, however, that the BOC still has a long-term hiking bias. The BOC just doesn’t want to hike too quickly. Even so, that’s a rather disappointing forward guidance, given the recent positive developments in the Canadian economy.

Looking Forward

As always, oil will try to dictate the Loonie’s price action. Even BOC Governor Poloz said as much when he said the following in a November testimony:

“If interest rates are holding constant, then it will be oil prices that do most of the acting.”

The big question, however, is whether OPEC’s extended oil cut deal will continue to offset the rise in U.S. oil output, or at least keep the faith alive that the oil glut is going away.

Of course, rate hike expectations will very likely continue to have an impact on the Loonie’s price action next year. Even Poloz had this to say in his November testimony:

“But if oil prices are constant, it tends to be expectations about interest rates that have their biggest influence on the [Canadian] dollar”

And while the renegotiation on NAFTA didn’t really have a very noticeable effect on the Loonie’s price action this year, it’s possible that NAFTA-related news will have a bigger impact on the Loonie’s price action next year since the BOC linked NAFTA to monetary policy when the BOC noted the following during December BOC statement (emphasis mine).

“The global outlook remains subject to considerable uncertainty, notably about geopolitical developments and trade policies.”

Also, do note that the COT report shows that large players are still net bullish on the Loonie (well, CAD futures at least).

Source: COT Report from the CFTC
Source: COT Report from the CFTC

However, CAD bulls have been trimming their positions since October, likely in response to the BOC’s more neutral forward guidance. Shorts, meanwhile, have been keeping their positions somewhat steady after slashing them in June.

So, if the BOC becomes more hawkish again, then there are still shorts left to squeeze out and bulls that took profits off the table may get enticed to jump back in.

Of course, the converse is also true in that a more bearish BOC will likely encourage the shorts who got squeezed out back in June to jump back in.