Canadian Dollar benefits from softer US Dollar despite lower Oil prices

USD/CAD trades near 1.4105 on Tuesday at the time of writing, down 0.14% on the day, though the pair remains close to its recent highs as traders refrain from taking aggressive positions ahead of the Federal Reserve (Fed) monetary policy decision. The US Dollar (USD) lacks a clear direction as markets widely expect the central bank to leave interest rates unchanged, with attention now turning to updated economic projections and comments from Fed Chair Kevin Warsh.

The Canadian Dollar (CAD) is attempting a modest rebound, but its upside remains limited by the continued decline in Oil prices. West Texas Intermediate (WTI) Oil has fallen to a fresh weekly low as negotiations between the United States (US) and Iran continue in an effort to preserve the ceasefire despite recent violations. For an economy heavily reliant on energy exports such as Canada, a sustained decline in Oil prices tends to weaken the domestic currency.

On the political front, US President Donald Trump once again urged the Fed to lower interest rates, arguing that recent inflation data justify monetary easing. Trump also struck a more conciliatory tone toward Iran, saying he wants to avoid targeting critical infrastructure while warning that Tehran can no longer violate existing agreements, helping to ease fears of a broader escalation in the Middle East.

The latest US economic data paint a mixed picture. The four-week average of the ADP Employment Change fell to just 15K, highlighting a gradual slowdown in labor market momentum. Meanwhile, the Conference Board Consumer Confidence Index eased to 90.8 in July from 92.2 previously, pointing to a modest deterioration in household sentiment. These indicators support expectations that the Fed could adopt a less hawkish tone in the coming months, although policymakers are still widely expected to keep interest rates unchanged at this week's meeting.

CAD holds near fair value as rate gap with USD caps upside

Strategists at Scotiabank note that the Canadian Dollar is treading water against Greenback, with the bank observing that “the CAD is holding little changed against the generally stronger USD.” They judge the currency to be broadly fairly valued at current levels, pointing out that their “fundamental fair value estimate suggests spot is trading right about where it should be in broad terms, with the equilibrium estimate edging up to 1.4086 today.”

On the drivers, Scotiabank highlights that “softer crude oil is a mild headwind but the real constraint on the CAD still comes from wide short-term interest rate differentials relative to the USD.” The bank adds that “a Fed hold tomorrow may allow the CAD to improve a little but scope for improvement is limited absent a significant narrowing in rate differentials—which we do not expect to develop until later this year.”