USD/CAD holds ground near 1.3750 as inflation risks add to Fed policy uncertainty
- USD/CAD gains ground as the Greenback advances, driven by persistent inflationary pressures.
- The CME FedWatch tool indicates more than 89% of a 25-basis-point Fed rate cut in September.
- The Q2 GDP contraction has led markets to advance expectations for Bank of Canada policy easing.
USD/CAD extends its gains for the second successive session, trading around 1.3750 during the Asian hours on Monday. The pair appreciates as the US Dollar (USD) is gaining ground as traders assess Friday’s United States (US) Personal Consumption Expenditures (PCE) Price Index, which signaled persistent inflationary pressures and heightened uncertainty over potential rate cuts. The August ISM Manufacturing Purchasing Managers Index (PMI) will be eyed later in the day.
However, the upside of the USD/CAD pair could be limited as the US Dollar (USD) may struggle amid the increasing likelihood of a US Federal Reserve (Fed) rate cut in the September meeting. Traders are now pricing in more than 89% of a 25 basis points (bps) rate cut by the Fed at the September policy meeting, up from an 84% chance a week ago, according to the CME FedWatch tool.
Market participants are also awaiting labor market data this week that could shape the US Federal Reserve’s (Fed) policy decision in September. Key reports include ADP Employment Change, Average Hourly Earnings, and Nonfarm Payrolls for August.
The Canadian Dollar (CAD) faces headwinds as the domestic economy slows more sharply than anticipated, weighed down by a simmering trade dispute with the United States and elevated tariffs under US President Donald Trump. Statistics Canada reported a 0.4% quarter-on-quarter contraction in Q2 real GDP, driven by weakness in exports and business investment, prompting markets to bring forward expectations for Bank of Canada (BoC) policy easing.
Canadian Dollar FAQs
The key factors driving the Canadian Dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of Oil, Canada’s largest export, the health of its economy, inflation and the Trade Balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – with risk-on being CAD-positive. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian Dollar.
The Bank of Canada (BoC) has a significant influence on the Canadian Dollar by setting the level of interest rates that banks can lend to one another. This influences the level of interest rates for everyone. The main goal of the BoC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former CAD-negative and the latter CAD-positive.
The price of Oil is a key factor impacting the value of the Canadian Dollar. Petroleum is Canada’s biggest export, so Oil price tends to have an immediate impact on the CAD value. Generally, if Oil price rises CAD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Oil falls. Higher Oil prices also tend to result in a greater likelihood of a positive Trade Balance, which is also supportive of the CAD.
While inflation had always traditionally been thought of as a negative factor for a currency since it lowers the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to lead central banks to put up interest rates which attracts more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in Canada’s case is the Canadian Dollar.
Macroeconomic data releases gauge the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment but it may encourage the Bank of Canada to put up interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.
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