Will crude oil cause a Canadian dollar crash?

The energy sector and Forex markets are currently in a unique trading environment, especially for crude oil and the Canadian dollar. Currently, CAD and crude oil share a positive correlation of +0.30. With the recent decline in oil prices, the current market conditions may potentially lead to a crash in the Canadian dollar.

How might crude oil prices affect Canadian dollar?

Crude oil prices have fallen by 14% since October 19th, moving from nearly $90 a barrel to $75 a barrel in less than a month. Many are speculating whether this decline will continue to more historically normal prices for crude oil in the 60s or low 70s ($/barrel).

The global fear of an economic recession is beginning to impact markets like crude oil, which are largely dependent on demand from economies such as China, Europe, and the United States. Recent geopolitical turmoil, such as the war in the Middle East and the Russian-Ukrainian conflict, has been a another significant factor in keeping crude oil prices high. However, market sentiment suggests that the risk around crude oil has lessened over the last few weeks.

Over a 15-year period, the correlation between crude oil and the Canadian dollar has been exclusively positive. For instance, from 2010 to 2015, when crude oil was trading around $90 to $100 a barrel, the Canadian dollar was trading around parity. Similarly, when crude oil prices fell to lows in 2020, the Canadian dollar weakened against US dollar – with USD/CAD reaching highs above 1.4000.

However, recent trends seem to indicate a deviation from this historical correlation. Despite crude oil prices reaching over $100 a barrel in 2022 due to geopolitical tensions and inflation, the Canadian dollar did not rally as much as historical precedent would suggest. The strength of the US dollar, influenced by its aggressive interest rate hikes and outperformance of global economies, including Canada, may be a contributing factor to this deviation.

In this new environment, if crude oil prices continue to fall and geopolitical tensions ease, the Canadian dollar could potentially reach new lows. The US’s strength from an economic and interest rate perspective could exacerbate this decline. On the other hand, if crude oil prices stabilize and the interest rate environment in the US weakens, the Canadian dollar could potentially strengthen.

At present, the historical correlation between crude oil and the Canadian dollar cannot be ignored, but the current market conditions present a unique and nuanced environment. It remains to be seen how these factors will play out, but forex traders should keep oil prices in mind to prepare for potential significant moves in USD/CAD and other markets.