Canadian Dollar remains resilient as Oil strength counters firmer US Dollar
- USD/CAD struggles for direction as a firmer US Dollar and elevated Oil prices pull the pair in opposite directions.
- The US Dollar rebounds from two-month lows as US Treasury yields climb.
- Energy-driven inflation risks keep the possibility of a Fed rate hike later this year alive.
USD/CAD trades little changed on Tuesday as rising long-term US Treasury yields lift the US Dollar (USD), while elevated Oil prices underpin the commodity-linked Canadian Dollar (CAD). At the time of writing, the pair trades around 1.3874, near levels last seen in early June.
The benchmark 10-year US Treasury yield has climbed toward 4.75%, while the 30-year yield has risen above 5.30%, its highest level since 2007. Higher yields help the US Dollar stage a modest recovery from two-month lows touched on Monday.
The US Dollar Index (DXY), which tracks the Greenback's value against a basket of six major currencies, trades around 99.67, up 0.10% on the day. However, Oil price movements are likely to remain the main near-term driver of USD/CAD.
Analysts at Commerzbank note that “the performance of the Canadian dollar has understandably been closely linked to the oil price in recent months.” They argue that this dynamic is unlikely to fade quickly and that “this trend is likely to continue unless the Strait of Hormuz is kept open on a sustained basis.”
West Texas Intermediate (WTI) crude Oil trades around $84.25 per barrel after gaining 3.15% on Monday, holding near its highest level in over two weeks.
Higher Oil prices keep inflation concerns in the spotlight. Data released on Monday showed that Canada’s Consumer Price Index (CPI) accelerated to 3.0% YoY in July from 2.8% in June. Even so, the data did not materially change market expectations for the Bank of Canada (BoC).
According to economists at TD Securities, the latest Canada CPI report showed that "core inflation measures looked a little less benign than prior months." In their view, this backdrop means "the Bank of Canada can stay patient as it waits for more clarity around the growth outlook beyond Q2," and TD Securities reiterates that they "continue to look for the Bank to stay on hold through 2026."
On the US side, recent weaker economic data have prompted traders to scale back expectations of a Federal Reserve (Fed) rate hike at the September meeting. However, energy-driven inflation risks keep the possibility of a rate increase later this year alive.
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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