Welcome to the March edition of The George Davis Report. We've gotten a lot of questions from clients and had a lot of discussions with clients over the past week about the price action that we've seen in the Canadian dollar after the beginning of the Iran war. And one of the things that really stands out is the strength that we've seen in the Canadian dollar since the beginning of the war. And given the fact that we've had a selloff in equity markets and more of a risk off backdrop, a lot of people are surprised at the resiliency of the Canadian dollar and want to dig a little bit further in terms of what themes are driving that move. So that's what I thought I would address with you today: the price action that we've seen in the Canadian dollar over the past week since the beginning of the war.
Now, if you take a look at the chart on the screen, you'll notice that the Canadian dollar has actually been the best performing of all the major currencies since the beginning of the Iran war and going to today's date of filming, as of March the 10th, we have the Canadian dollar up about 0.8%. And you can see how some of the other currencies have fared as well. But what really stands out is the fact that the Canadian dollar has indeed been the strongest performer.
Now, with the US dollar actually rallying about 2% more broadly in response to the war and the risk off backdrop, it's somewhat surprising that we've seen the Canadian dollar strengthen. Because as you recall, we've looked at our correlation model multiple times and highlighted the fact that broader US dollar direction tends to be the primary driver of dollar Canada. And so, with the US dollar being stronger more broadly, one would generally expect dollar Canada to be higher as well. And if you look at the chart on the screen right now, you'll notice we have that relationship between broader US dollar movement and dollar Canada, and you can see that the correlation is quite strong at plus 0.66. And so again, normally you would expect to see, given that relationship, dollar Canada stronger as opposed to weaker. And so that's the big question: “Why is dollar Canada weaker in the current environment?”
So generally, when the US dollar moves more broadly higher, we tend to see, as we've discussed, dollar Canada nudge higher. However, during that process, the Canadian dollar tends to weaken less so against the US dollar relative to other currencies such as the Euro, the pound sterling, and the Japanese yen. And so that allows the Canadian dollar to outperform against those currencies on the crosses. And this is what we refer to as the Canadian dollar sometimes trading as a “mini dollar”: that relationship that, as the US dollar strengthens, the Canadian dollar also tends to strengthen against some of the other major currencies.
Now, you can see the examples of that in the areas shaded in light gray in the chart on the screen, and you can see how those relationships have fit. Again, the US dollar moving higher, dollar Canada moving higher, and the Canadian dollar strengthening on the crosses.
Now, you'll also notice in the area shaded in light blue, there have been two exceptions to this relationship. The first one goes back to the Russia invasion of Ukraine in 2022, and the second one is in the current environment. And on both of those occasions, we have one commonality in terms of what has happened in some of the other asset classes and that is, on both of those occasions, we've seen a very strong and sudden spike higher in crude oil prices. In terms of the Russian invasion, we saw a very quick roughly 47% increase in oil prices. In this instance, we've seen roughly a 45% increase in WTI crude oil prices.
So that sudden shock tends to be more positive for the Canadian economy because we are a net exporter of oil and gas and commodities in general. So as those prices firm up, that tends to be more positive for our terms of trade. And really it has to do with the magnitude of the move. It's not just that oil prices are up 2 or 3%, it's a sudden 40 to 50% increase. And so there's a shock that's impacting the markets, and that really tends to explain why we have seen the Canadian dollar strengthen as opposed to weaken in the current environment.
And so really it sets us up with two potential outcomes as we go forward. Obviously, there's going to continue to be a lot of headline risk, a lot of volatility around the headlines. But as long as we see the war persist and we see firmer WTI crude oil prices, that's likely to be a backdrop that's more positive for the Canadian dollar. In other words, dollar Canada likely to continue to be weighed down.
On the flip side, if we happen to see some sort of improvement in the risk backdrop, whether it be news of negotiations on a potential ceasefire or peace agreement, or anything along those lines, that would be an environment where we would expect to see some of that Canadian dollar strength unwound. Because if we do move towards a resolution of the conflict, generally speaking, that would take some of the upward pressure off of crude oil prices and, as a result, we'd see the Canadian dollar weaken off a little bit more. And so those are the two scenarios I think you want to focus on going forward.
Now, in terms of our expected trading range in the month ahead, I'm going to lower it just a touch. We're going to go 1.3400/1.3500 on the downside, and we will go with 1.3800/1.3900 on the topside. And again, those will give you some ranges to reference whether you're a buyer of US dollars or a seller of US dollars. You can work within that framework in the month ahead.
Now, stay tuned for our next update, where we'll reassess the risk backdrop and what's going on with the Iran war, and see what the implications are for financial markets going forward.