Canadian Dollar bears retain control near August 7 low amid US-Canada rate gap/trade war

USD/CAD is seen consolidating its recent strong gains registered over the past week or so.
The wide US-Canada rate gap and trade tensions undermine the CAD, supporting the pair.
The recent rise in oil prices fails to support the Loonie, while the hawkish Fed favors USD bulls.

Haresh Menghani FXStreet

The USD/CAD pair oscillates in a narrow band during the Asian session on Friday, trading below the 1.4000 psychological mark or the highest level since August 7, touched earlier this week. Nevertheless, spot prices remain on track to register gains for the second straight week and seem poised to prolong an over one-week-old uptrend amid a supportive fundamental backdrop.

The Canadian Dollar (CAD) has been underperforming against its American counterpart due to the widening US-Canada rate gap, which, in turn, continues to act as a tailwind for the USD/CAD pair. In fact, the Bank of Canada (BoC) maintained its key policy interest rate at 2.25% earlier this month. The US Federal Reserve (Fed), on the other hand, raised its benchmark rate for the first time in over three years, by 25 basis points (bps) to a range of 3.75%–4.00% on Wednesday.

CAD underperforms as Fed–BoC spread widens and USD stays rich

Strategists at Scotiabank note that the renewed widening in US–Canada rate differentials is weighing heavily on the Loonie. With the “Fed/BoC policy rate differential back to 175bps, where it spent much of last year, wider front-end spreads account for the CAD’s softness and underperformance.” They add that their “fair value model indicates an equilibrium exchange rate of 1.3894, indicating that there is a degree of USD overvaluation in current spot rates but, with little prospect of that gap narrowing anytime soon, the CAD may find it hard to recover meaningfully for now.”

Adding to this, ongoing US-Canada trade tensions turn out to be another factor undermining the commodity-linked Loonie. The US imposed steep 50% tariffs on approximately $20 billion worth of Canadian goods on August 22, while Canada implemented retaliatory tariffs ranging from 15% to 50% on roughly $20 billion worth of US goods on September 8. This offsets the recent surge in crude oil prices and fails to ease the bearish pressure surrounding the commodity-linked Loonie.

Meanwhile, Fed Chair Kevin Warsh’s focus on inflation calmed the recent selloff in the fixed-income market and dragged US bond yields away from multi-year highs. This keeps the US Dollar (USD) on the back foot and acts as a headwind for the USD/CAD pair. That said, the US central bank's hawkish outlook, signaling one more rate hike this year, and persistent geopolitical uncertainties should act as a tailwind for the safe-haven buck, which, in turn, favors USD/CAD bulls.

USD/CAD daily chart

Technical Analysis:

The USD/CAD pair a constructive near-term bullish bias following the post-Fed breakout through the 1.3940 confluence – comprising the 100-day Simple Moving Average (SMA) and the 38.2% Fibonacci retracement level. Bulls now await acceptance above the 50.0% retracement at 1.3993 before positioning for further move up to the 61.8% level at 1.4054 and then 78.6% at 1.4141, ahead of the cycle high anchor near 1.4251.

On the downside, the 1.3940 confluence resistance breakpoint now seems to act as an immediate support. This is followed by deeper structural floors at 1.3857 and 1.3736, levels that would need to give way to weaken the current bullish tone.

(The technical analysis of this story was written with the help of an AI tool. Know more.)

Canadian Dollar FAQs

What key factors drive the Canadian Dollar?

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.

How do the decisions of the Bank of Canada impact 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.

How does the price of Oil impact the Canadian Dollar?

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.

How does inflation data impact the value of the Canadian Dollar?

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.

How does economic data influence the value of 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.

Author

Haresh Menghani

FXStreet

Haresh Menghani is a detail-oriented professional with 10+ years of extensive experience in analysing the global financial markets.

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