Canadian Dollar weakens as US Dollar strengthens on rising risk aversion
- USD/CAD advances as US-Iran conflict and Strait of Hormuz tensions heighten market anxiety.
- Lowers September rate hike odds after Nonfarm Payrolls unexpectedly dropped in July.
- Rebounding WTI price may provide underlying support for the commodity-linked Canadian Dollar.
USD/CAD gains ground after registering over 0.5% losses in the previous day, trading around 1.3950 during the early European hours on Monday. The pair gains ground as the US Dollar (USD) strengthens on rising safe-haven demand, driven by heightened geopolitical caution.
Middle East tensions remain elevated as the ongoing US-Iran conflict enters a critical diplomatic phase, marked by intense military engagements and strategic pressure surrounding the Strait of Hormuz. Tehran noted that talks with Oman to establish a safe shipping route through the strategic waterway are nearing an agreement, though it cautioned that any deal would not lead to an immediate reopening.
Additionally, Iran-backed Houthi militants in Yemen claimed a recent attack on Saudi Arabia’s Jazan refinery, while a tanker operated by the Abu Dhabi National Oil Co. was targeted in the Strait. Meanwhile, Tehran has rejected direct negotiations with the United States for now, citing alleged breaches of the interim peace deal reached in June.
On the economic front, US Nonfarm Payrolls (NFP) unexpectedly dropped by 23,000 in July, while sharp downward revisions to June’s figures, falling to 20,000 from an initially reported 57,000, highlight weakening labor market conditions. Consequently, the CME FedWatch Tool suggests markets now see nearly a 44% probability of a 25-basis-point rate hike in September, down from 67% a week earlier. Investors are currently turning their focus to upcoming inflation reports for further clues on the direction of monetary policy.
Despite these tailwinds for the US Dollar, upside potential for the USD/CAD pair could be restrained by support for the commodity-linked Canadian Dollar (CAD). Oil prices have rebounded, with West Texas Intermediate trading around $77.20 per barrel as it pares losses from the previous session. Persistent uncertainty surrounding efforts to reopen the crucial Strait of Hormuz continues to underpin crude prices, offering a counterweight to the US Dollar's momentum.
Canadian labor market surprise bolsters case for Dollar resilience
Analysts at Commerzbank underline that, “in contrast to the US labour market, the Canadian labour market delivered a very positive surprise on Friday,” with hiring momentum far outpacing expectations. They note that while “the median Bloomberg consensus forecast had predicted the creation of 20,000 new jobs, roughly 75,000 were actually created,” underscoring the strength of the latest report. In their view, this surge in employment has already fed through to headline indicators, as “in light of these figures, the unemployment rate also fell unexpectedly to 6.4%, its lowest level in two years, marking a decline of half a percentage point over the past three months.” Against the backdrop of improving GDP, PMI and export data, Commerzbank sees this robust labour performance as reinforcing the narrative of a recovering real economy, even if they caution that the upswing remains vulnerable to shifts in US trade policy.
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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