Canadian dollar hovers above 78 cents US as oil drops to 6-year low

The Canadian dollar is hovering at just over 78 cents US today as oil fell to its lowest level since 2009, beginning a week that many watchers say could be crucial for both the loonie and oil.

Oil lost another dollar early Monday, with the most prominent West Texas Intermediate contract trading down $1.07 to $43.77 US a barrel.

Western Canada Select, a Canadian contract, dipped below the key $30 a barrel level before closing at $30.28, a significant discount to world oil prices. The Canadian dollar, which is closely tied to the price of crude, dipped before closing at 78.28 cents US, unchanged from Friday.

I have a feeling that oil could go as low as $20.— Raoul Pal, Global Macro Investor

After appearing to hit a floor at around $48 for the past month, WTI oil seems to have renewed its slide, as it's become clear that producers are pumping out just as much oil as ever and keeping it in storage, waiting for prices to rebound.

"I'd been calling for oil to fall from $30 to $40 since the middle of last year," said Raoul Pal, publisher of the Global Macro Investor. "But now looking at the structure of what's going into storage, I have a feeling that oil could go as low as $20 over the next year and a half."

That's bad news for places like Canada, but good news for much of the U.S. economy. The shot in the arm of cheap oil could be enough, many experts say, to compel the Federal Reserve to start hiking rates soon to stave off the inflation that comes with a warming economy.

Nobody expects Federal Reserve chair Janet Yellen to hike the benchmark interest rate when the central bank board meets on Wednesday to decide its latest policy on interest rates. But many say the language the Fed chooses in explaining its thinking is just as important.

For months now, the central bank has said it will be "patient" in determining whether or not to change its benchmark interest rate, and by how much. But with the U.S. economy churning out stronger results each week, the belief among some is that the Fed may stop using that cautious word — which would be a sign it's getting ready to act.

Different directions

In a note to clients early Monday, Scotiabank said it would be looking for the "removal of 'patient' in favour of language that connotes flexibility to raise the federal funds target rate at any point from June onward."

But that wouldn't mean it's a sure thing that hikes are imminent. As the bank's economist Derek Holt said on Friday, "I do not expect any specific meeting to be teed up for liftoff just yet."

Wednesday's Fed decision could set the tone for the value of the dollar and by extension the price of oil for the next little while

"What people will be paying attention to is the Fed meeting on Wednesday," said Randy Frederick managing director of trading and derivatives with the Schwab Center for Financial Research. "The Fed is always a catalyst [for the market], the question is whether it's going to be a catalyst to the upside or the downside."

The U.S. is seemingly gearing up to ratchet rates higher, but Canada has taken the opposite tack, cutting its benchmark rate in February, with another one to come next week, according to a consensus of economists. If Canada moves to lower rates at the same time the U.S. signals it will raise them, it could mean a further decline for the loonie.

"I think the U.S. dollar is going to rise dramatically and that itself will put pressure on oil," and by extension the Canadian dollar, Pal said in an interview. The loonie was changing hands at 78.15 cents US early Monday, down about a tenth of a cent on the day. 

Divergent monetary policies could push the loonie as low as 75 cents sometime this year, Capital Economics said late last week. "We think short-term interest rates and the Canadian dollar will remain low for a lot longer than is widely anticipated," David Madani noted.