The Canadian dollar (CAD or loonie), like nearly all G10 currencies, advanced in April versus the US dollar (USD), with global risk sentiment turning more positive despite the continued elevated price of crude oil, said MUFG.
Global equities rebounded sharply, with the high level of crude oil not yet prompting investors to price an increased probability of global recession, writes the bank in its Month Foreign Exchange Outlook for May.
In real terms, the price of crude oil remains relatively low and there was a large global stock of crude oil (8.2 billion barrels) before the Middle East conflict began, which has helped curtail the surge in energy prices, said MUFG. But each day that passes, the risks of increased volatility in financial markets rise, it added.
CAD resilience reflects, to some degree, the terms of trade support, but other uncertainties are countering that support, said the bank.
The Bank of Canada, like the Federal Reserve, looks more likely to look beyond the energy-related lift to inflation and could well be slow to hike rates. BoC Governor Tiff Macklem stated after the meeting in April that a policy rate "close to current settings" would be appropriate for returning inflation to target. However, Macklem was clear that if inflation persisted, action would be required, MUFG noted.
An approach aligned with the Fed suggests the two-year United States-Canada swap spread can continue to trade in a relatively narrow range that would be consistent with USD/CAD remaining in a narrow trading range as well, said MUFG.
Renewed conflict and equity market volatility picking up would see CAD underperform, it added.
The bank's lower USD/CAD forecast is based on de-escalation and a gradual decline in crude oil prices and, as such, there are risks USD/CAD could be higher on a more prolonged conflict.