Canadian Dollar: Cautious Outlook into Year-End – NBC

The Canadian dollar has seen increased volatility recently. National Bank of Canada strategist Kyle Dahms analyzes that the loonie's correlation with WTI crude oil is slightly positive, but its links to gold and the two-year yield spread are more significant. With WTI crude currently trading near $102.08, oil price swings may have less direct pull on the Canadian dollar than market intuition suggests.

**Geopolitical Risk Premium and Market Expectations**

Following reported renewed tensions in the Strait of Hormuz in August, the market-implied probability of a return to normalcy before year-end has fallen from over 50% to below 30%. This shift keeps oil and gold prices reflecting geopolitical risk premiums, indirectly affecting risk appetite for the Canadian dollar. However, given the loonie's stronger correlation with gold, gold price fluctuations may explain more of the Canadian dollar's moves than oil prices.

**Rate Outlook and Policy Caution**

The Bank of Canada has held its overnight rate at 2.25% and maintains a wait-and-see stance. NBC strategists believe downside risks to growth warrant greater caution before considering another rate hike. The two-year yield spread has thus become a more important driver for the Canadian dollar; if Canadian government bond yields rise relative to U.S. Treasuries, the risk bias favors the loonie, but the overall outlook remains cautious.

**Implications into Year-End**

Overall, the Canadian dollar lacks momentum for a one-sided trend in the near term. Although oil prices are elevated, the loonie's correlation with WTI is limited, with more influence coming from yield spreads and gold movements. The strategist advises maintaining caution on the Canadian dollar into year-end, avoiding excessive bullishness based on oil strength alone.