Canadian Dollar eases from highs as risk aversion buoys the US Dollar
- USD/CAD returns above 1.3800 after bouncing from session lows at 1.3775.
- Risk aversion stemming from rising tensions in the Middle East is offsetting the impact of higher Oil prices.
- Risk aversion has provided some support to the USD, but markets remain muted, awaiting Friday's US CPI release.
The Canadian Dollar (CAD) is giving back previous daily gains against the US Dollar (USD) on Tuesday, as the risk-off mood amid escalating tensions in the Middle East offsets the positive impact of higher Crude prices on the commodity-sensitive Loonie. The USD/CAD pair has returned above 1.3800 from session lows at 1.3775, although it holds marginal lows on the daily chart.
Market sentiment remains frail on Tuesday as hopes of a negotiated end to the Middle East conflict move further away. Iranian authorities threatened on Monday with attacks on energy infrastructure across the Gulf, including US Oil and Gas interests, if their country is targeted again, and Qatar authorities have called for efforts to reopen the key Strait of Hormuz to avoid an “industrial catastrophe”.
The stalemate in the US-Iran conflict, which has extended for six months, has pushed Brent Oil prices to two-month highs above $97.00 per barrel, keeping the Canadian Dollar from depreciating further, as Crude Oil is Canada's main export.
CAD underperforms as US payrolls surprise and BoC support fades
On the macroeconomic front, TD Securities' analysts observe that the latest labour market data delivered a clear blow to the Canadian Dollar, amid a “genuine upside surprise in US payrolls and downside surprise in Canada,” according to the experts, “to overwhelm the temporary support from the BoC's hawkish tilt.”
Looking ahead, TD Securities "expect(s) CAD to underperform its peers going forward,” even as trade developments inject headline risk. While “tariff headlines may generate volatility into the September 8 deadline,” TD Securities cautions that “a meaningful breakthrough appears unlikely and the broader USMCA outlook remains largely unchanged,” limiting the scope for a sustained CAD rebound.
Regarding the Greenback, strategists at Brown Brothers Harriman highlight that Brent crude's surge after “Iran-backed Houthi militants reportedly targeted Saudi oil facilities on Monday and Tuesday (...) is weighing on stocks and bonds, while giving USD a modest lift.”
Nonetheless, BBH stresses that “Friday’s US August CPI report remains the main near-term market driver that will decide the Fed’s September 16 rate decision.” In their view, “a hot CPI print would all but seal a September hike and underpin a firmer USD,” whereas “a cooler reading would strengthen the case for a hold and leave USD vulnerable to a dovish Fed repricing.”
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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