The USD/CAD pair trades in positive territory for a fourth consecutive day near 1.3600 during the early Asian session on Wednesday. The US Dollar (USD) gains ground after the better-than-expected Retail Sales data. Traders brace for the Federal Reserve (Fed) interest rate decision on Wednesday, which is widely anticipated to lower its interest rate for the first time in more than four years.
Data released by the Commerce Department on Tuesday showed that US Retail Sales unexpectedly rose 0.1% MoM in August versus 1.1% prior. This figure was above the market consensus of -0.2% and suggested a sign of resilience among US households. Meanwhile, Industrial Production came in better than the estimation, climbing 0.8% MoM in August, compared to a decline of 0.6% in the previous reading.
However, the August Retail Sales and Industrial Production reports did not convince the Fed officials much about the size of the rate cut at its September meeting. According to the CME Fedwatch Tool, Fed funds futures have priced in a nearly 63% chance of a 50 basis points (bps) rate cut, up from 30% a week ago, while the odds of a 25 bps cut were at 37%. The jumbo Fed rate cut could further undermine the USD against its rivals.
The Canadian Consumer Price Index (CPI) hit the 2% target in August as inflation continued a downward trajectory. The country’s CPI rose 2.0% YoY in August, compared to 2.5% in July, softer than the 2.1% expected, Statistics Canada showed Tuesday. On a monthly basis, the CPI figure was -0.2% in August versus 0.4% prior.
The rising speculation that the Bank of Canada (BoC) will cut additional interest rates weighs on the Canadian Dollar (CAD) and acts as a tailwind for USD/CAD. Money markets are fully pricing in 25 bps rate cuts at each of the last two monetary policy meetings this year. Meanwhile, expectations of a 50 bps cut in the October meeting rose to 47.5% from 46% before the CPI data.
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.