Canada: Investment Opportunities in USD/CAD if Iran-Israel Conflict Reignites

Executive Summary

Although the Iran-Israel conflict has subsided, a re-escalation could drive oil prices higher in the short term. As a major resource-exporting nation, the Canadian dollar (CAD) is closely tied to oil prices—higher oil prices typically strengthen the CAD. However, in the medium term, the USD/CAD exchange rate is influenced by three key factors. First, Canada’s slowing economic growth, combined with a significant policy rate differential between the Federal Reserve and the Bank of Canada, weighs on the CAD. Second, increased OPEC+ spare capacity and potential energy policies under a Trump administration are likely to pressure oil prices downward, weakening the CAD. Third, persistent U.S. economic weakness will eventually slow global growth, enhancing the U.S. dollar’s safe-haven appeal and further depressing the CAD. Driven by economic slowdown, wide rate differentials, declining oil prices, and a stronger USD, we expect the CAD to weaken over the medium term. Should a rekindled Iran-Israel conflict temporarily boost the CAD due to rising oil prices, it would present an attractive entry point for CAD bears.

Source: TradingKey

* Investors can directly or indirectly invest in the foreign exchange market through passive funds (such as ETFs), active funds, financial derivatives (like futures, options and swaps), CFDs and spread betting.

1. Recent Forex Trends

Since early February 2025, the Canadian dollar (CAD) has maintained a steady upward trend. This appreciation can be divided into two distinct phases based on driving factors. The first phase, from early February to early May, saw the CAD strengthen primarily due to a weakening U.S. dollar index, influenced by Trump’s tariff policies and global de-dollarisation trends (Figure 1.1). The second phase, from early May to the present, has been marked by continued USD weakness, coupled with rising oil prices that further bolstered the CAD (Figure 1.2). However, recent volatility in global oil prices, triggered by the Iran-Israel conflict and subsequent ceasefire negotiations (see 24 June 2025, article: “Iran Strikes US Military Base, Yet Oil Prices Drop Sharply! Experts Suspect It Was Staged”), has led to fluctuations in the CAD exchange rate.

Figure 1.1: USD/CAD and USD Index

Source: Refinitiv, TradingKey

Figure 1.2: USD/CAD and Crude Oil Prices (USD/bbl)

Source: Refinitiv, TradingKey

2. Short-Term Forex Outlook

In the short term, we believe the most direct and significant factor influencing the Canadian dollar (CAD) remains Middle East geopolitics. Although the Iran-Israel conflict has subsided, any re-escalation could present investors with a compelling opportunity. While Iran accounts for only 3.9% of global crude oil supply, the broader Middle East and North Africa region contributes 34.5% (Figure 2). If the conflict escalates and affects other Gulf oil-producing nations, the global oil supply could face significant disruptions, driving up oil prices. As a major resource exporter, Canada’s economy and currency are closely tied to oil prices. Rising oil prices would improve Canada’s terms of trade, boost export revenues, and likely strengthen the CAD.

Figure 2: Oil Supply (% of global)

Source: Refinitiv, TradingKey

3. Mid-Term Forex Outlook

In the medium term, the USD/CAD exchange rate is driven by three key factors. First, Canada’s macroeconomic conditions and monetary policy. Although delayed by 90 days, the anticipation of Trump’s reciprocal tariffs has already begun to negatively impact the Canadian economy. Recent high-frequency data, such as Retail Sales and PMI, have shown disappointing results. Looking ahead, under pressure from U.S. tariff policies, Canada’s economic growth is expected to slow, weighing on the Canadian dollar (CAD). Additionally, following significant rate cuts over the past year, the Bank of Canada’s policy rate is now substantially lower than the Federal Reserve’s. With the Bank of Canada likely to continue cutting rates, this is expected to further weaken the CAD (Figure 3.1).

Second, the mid-term trajectory of international oil prices. Crude oil prices are expected to gradually decline due to supply-side factors. OPEC+ maintains significant spare capacity, and potential energy policies under a Trump administration could further suppress oil prices. Even if a failure in the Iran-Israel ceasefire triggers a short-term spike in oil prices, enhanced supply responses are likely to drive a mid-term price correction. This would negatively impact the Canadian dollar (CAD) exchange rate.

Third, the mid-term trajectory of the U.S. dollar index. In the short term, Trump is expected to engage in negotiations with multiple countries, which may temporarily ease global trade tensions. However, we believe high-tariff policies and an unpredictable diplomatic approach will remain defining features of a Trump administration, making it unlikely for trade disputes to be fundamentally resolved. Consequently, in the medium term, escalating global trade conflicts are likely to weigh on the U.S. economy and trigger global ripple effects. During such periods, the U.S. dollar, as a safe-haven currency, is expected to strengthen, driving an appreciation of USD/CAD.

Driven by a weakening economy, wider interest rate differentials, declining oil prices, and a strengthening U.S. dollar, we expect the Canadian dollar (CAD) to trend lower in the medium term. Should a rekindled Iran-Israel conflict temporarily boost the CAD, this would present an attractive entry opportunity for CAD bears (Figure 3.2).

Figure 3.1: Fed and BoC Policy Rate (%)

Source: Refinitiv, TradingKey

Figure 3.2: USD/CAD Outlook (%)

Source: Refinitiv, TradingKey

* For further details supporting our foreign exchange market views, please refer to the macroeconomic section below.

4. Macroeconomics

In the first quarter of this year, Canada’s real GDP growth reached 2.3%, around one percentage point above the 2023 and 2024 average (Figure 4.1). However, this strong performance was primarily driven by Canadian firms’ front-loading export activities, which are unlikely to be sustainable. Although delayed by 90 days, the anticipation of Trump’s reciprocal tariffs has already begun to exert a negative impact on the Canadian economy. On the demand side, reduced household income has led to a persistent decline in Retail Sales growth since March this year, with the latest May data recording negative growth (Figure 4.2). On the production side, Manufacturing and Services PMIs stood at 46.1 and 45.6, respectively, well below the 50 threshold, indicating continued contraction in business output.

Looking ahead, U.S. tariff policies remain the greatest threat to the Canadian economy. Tariffs are expected to impact Canada’s economy primarily through two trade channels:

· Petroleum Industry: Canada is the world’s fourth-largest oil producer, with 80% of its output exported, primarily to the United States. Tariffs on oil imports would significantly reduce Canada’s energy exports, weighing on GDP growth.

· Other Goods: High tariffs on non-energy exports would dampen U.S. demand. However, Canada could mitigate some of the impact by redirecting exports through third countries, thereby cushioning the blow to its export markets.

The direct effects of these tariffs, combined with indirect effects such as heightened concerns about economic prospects and market unease, are expected to influence Canada’s economic outlook in the medium to long term.

On the inflation front, falling energy prices have led to a consistent decline in Headline CPI in recent months. However, persistent increases in housing costs and service prices have kept the Bank of Canada’s preferred measure, Core CPI, above its 2% target (Figure 4.3). Despite the absence of a downward trend in Core CPI, we expect the Bank of Canada to continue cutting interest rates amid a weakening economic outlook (Figure 4.4).

Figure 4.1: Canada Real GDP (%, y-o-y)

Source: Refinitiv, TradingKey

Figure 4.2: Canada Retail Sales (%, m-o-m)

Source: Refinitiv, TradingKey

Figure 4.3: Canada CPI (%, y-o-y)

Source: Refinitiv, TradingKey

Figure 4.4: BoC Policy Rate (%)

Source: Refinitiv, TradingKey