Forex Investment and Currency Trading

The factors that have kept CAD/NOK range-bound are breaking down and bearish risks are increasing. As a result, CAD/NOK will continue to decline in the near term.

Short CAD/NOK is an oil neutral way to capture CAD-bearish economic stresses from the US slowdown that are weighing on the Canadian economy while the European economy, including Norway, displays ongoing resiliency.

CAD and NOK are oil sensitive currencies that strengthened as oil prices rose in recent years, leaving CAD/NOK largely rangebound. Now however, amid USD weakness, oil prices have rallied USD100/b, but CAD/NOK has broken toward multi-year lows as other factors are offsetting any CAD gains from recent oil price gains. CAD and NOK correlations with global equities and oil prices also suggest that other factors are leading to CAD underperformance. Most prominent among those factors is the US slowdown which is a more pressing bearish risk for CAD than for NOK owing to Canada’s still close economic link to the US. These concerns will linger as a bearish risk to CAD. Short CAD/NOK is a way to trade these developments without having to take an explicit view on oil prices. The collapse in US consumer confidence highlights the disturbing risk of a sharp US economic downturn, while the slide in the OECD leading economic indicator for Canada (which includes the US NAPM Manufacturing index that has dropped to recessionary levels) highlights the well explored stress facing the Canadian economy. Meantime, the economic cycle in Europe, excluding the UK that is, has proved remarkably resilient, reflected in this week’s surprising business confidence readings for March, with the German Ifo up from 110.3 to 111.5 (cons: 109.5) and the French Business Confidence Indicator up from 107 to 109 (cons: 106). It is also evident in the still elevated Norwegian OECD LEI, although Norway is not immune to global economic risks. The financial/credit crisis is also a greater risk to the Canadian outlook, as BoC Governor Carney said in a recent speech that “our economy is beginning to feel the effects of the deterioration in global financial conditions.” Meantime, Norges Bank’s recent Monetary Policy Report highlight that “domestic and external developments are diverging, although there was some tightening of credit conditions in Norway in Q4, with more expected in Q1.

This draws attention to the widening gulf in NO-CA interest rate spreads that are a headwind to CAD rallies on crosses, including CAD/NOK. Rates spreads reflect that the BoC has already responded to the rising economic risks and the worsening of the financial/credit crisis by cutting rates 100bp to 3.5% and retaining a bias to ease further. Norges Bank, conversely, retains a focus on upside inflation risks, while acknowledging the downside risks from credit market tightening and the US economic slowdown. The central bank biases also reflect divergent inflation scenarios. Core inflation in Norway has climbed through 2.0%y/, but Canadian core inflation has retreated from 2.5%y/y in mid-2007 to 1.5% in Canada. Accordingly, rate spreads have turned decidedly bearish CAD/NOK. The 2-year NO-CA swap spread has surged since the start of the financial crisis in the summer from below 1% in August 2007 to over 3% at present, a level last seen in early 2003 when CAD/NOK was trading near 4.5.

CAD/NOK broke below 5.0 this week, but there is still downside risk. Look for opportunities to short the currency pair.