The Canadian Dollar (CAD) struggles to build on gains against the US Dollar (USD) on Monday as a sharp pullback in Oil prices weighs on the commodity-linked Loonie, even as the Greenback trades under pressure.
At the time of writing, USD/CAD trades near 1.3584, trimming part of its earlier losses after falling to a daily low around 1.3525.
Canada is a major Oil exporter and is highly sensitive to fluctuations in global Oil prices. Estimates from Scotiabank suggest that a persistent Oil shock could boost Canadian GDP by roughly 0.5% over the next year, based on the estimated impact of a $10 per barrel increase in West Texas Intermediate (WTI) prices.
As the US-Iran conflict widens and continues to disrupt Oil flows through the Strait of Hormuz, WTI opened the week with a bullish gap, briefly climbing to around $113 per barrel before easing sharply from the highs. At the time of writing, WTI is trading near $91.40 per barrel.
The pullback comes after reports that G7 countries are discussing a coordinated release of Oil reserves through the International Energy Agency (IEA) to help ease supply concerns.
Despite the intraday retreat, Oil prices remain elevated. While higher Oil prices tend to support Canada’s growth outlook and the commodity-linked Loonie, they also risk reinforcing inflation pressure globally.
Against this backdrop, the Bank of Canada (BoC) is expected to adopt a wait-and-see approach, maintaining a steady policy stance for now while monitoring the potential inflationary impact of higher energy prices.
Across the border, markets are increasingly pricing in the Federal Reserve (Fed) to remain on hold for longer and have trimmed expectations for near-term rate cuts. According to the CME FedWatch Tool, the probability of a 25 basis-point rate cut in June stands at 35.3%, down from around 50% a month ago, while the odds of a cut by July stand near 41.2%.
Attention now turns to Canada’s employment data due on Friday, which will provide the final read on labor market conditions ahead of the BoC’s March monetary policy decision. In the US, the focus will be on Consumer Price Index (CPI) data on Wednesday and the Personal Consumption Expenditures (PCE) Price Index on Friday.
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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