Canadian Dollar weakens on risk-off mood, dovish BoC’s tone
- USD/CAD rises as the US Dollar gains on safe-haven support amid uncertainty over the US-Iran peace deal.
- CME FedWatch tool suggests a 40.2% chance of a year-end Fed rate hike due to persistent inflation concerns.
- A dovish economic outlook has significantly weakened the Canadian Dollar.
USD/CAD extends its gains for the second successive day, trading around 1.3810 during the early European hours on Monday. The pair appreciates as the US Dollar (USD) holds ground on increased safe-haven demand amid US-Iran peace uncertainty. The US ISM Manufacturing Purchasing Managers Index (PMI) report will be published later on Monday.
The geopolitical landscape remains fluid as diplomatic channels between Washington and Tehran experience ongoing activity. Iranian Foreign Minister Abbas Araghchi confirmed that talks and message exchanges with the United States are currently underway. However, Araghchi maintained a cautious stance, emphasizing that it remains impossible to properly evaluate the trajectory of these negotiations until a definitive and clear outcome is officially reached.
Adding momentum to these diplomatic efforts, US President Donald Trump has requested specific revisions to the proposed US-Iran deal. The agreement, which aims to permanently halt the hostilities that erupted earlier this year, is now facing adjustments centered on key security and non-proliferation issues. Specifically, the requested modifications focus on the strategic transit dynamics of the Strait of Hormuz and the management and removal of Iran's highly enriched uranium supplies.
Simultaneously, global financial markets are navigating shifting expectations for central bank policies. In the United States, macroeconomic sentiment has adjusted to factor in a tighter monetary environment for a bit longer. According to the CME FedWatch tool, traders are now pricing in a 40.2% probability that the Federal Reserve will implement a 25-basis-point interest rate hike before the year concludes, reflecting lingering caution over inflation and economic resilience.
In contrast, the Canadian economic outlook has taken a decidedly dovish turn, prompting a notable softening of the Canadian Dollar (CAD). Fresh economic data indicated that Canada’s economy unexpectedly contracted in the first quarter of 2026 relative to the previous year. Because this represents the second consecutive quarter of annual decline, the data highlights a clear loss of domestic momentum, which subsequently pushed the USD/CAD currency pair higher as the CAD lost ground.
This economic slowdown is further underscored by a sharp cooling in consumer prices across Canada. The BoC’s preferred core inflation metrics have slowed more than economists anticipated, touching their lowest levels in five years and signaling that underlying price pressures outside of the volatile energy sector are successfully easing. This cooling trend has firmly validated the central bank’s perspective that energy-driven inflation spikes may only be temporary. Consequently, the data has wiped out expectations for any near-term rate hikes, leaving market participants overwhelmingly confident that the Bank of Canada will hold interest rates steady at its upcoming policy meeting on June 10.
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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