Canadian Dollar remains on the front foot as USD bulls turn cautious ahead of Fed decision

USD/CAD remains on the defensive for the second straight day amid a combination of factors.
Rebounding oil prices underpin the Loonie and weigh on the pair amid subdued USD demand.
The downside seems limited amid US-Iran tensions and ahead of the key FOMC rate decision.

Haresh Menghani FXStreet

The USD/CAD pair is seen consolidating around the 1.4100 mark during the Asian session as traders keenly await the outcome of a two-day FOMC policy meeting, due later this Wednesday. Investors will look for fresh cues about the US Federal Reserve's (Fed) future policy path, which will play a key role in influencing the near-term US Dollar (USD) price dynamics and provide a fresh impetus to the currency pair.

In the meantime, the USD remains on the defensive below a one-month top, touched on Tuesday, as bulls turn cautious heading into the key central bank event risk. Furthermore, a solid recovery in crude oil prices from an over two-week low underpins the commodity-linked Loonie and turns out to be another factor acting as a headwind for the USD/CAD pair. However, persistent geopolitical uncertainties should support the safe-haven Greenback and limit the downside for the currency pair.

In fact, Iran's Islamic Revolutionary Guard Corps (IRGC) launched multiple ballistic missiles at US forces in the Middle East on Tuesday. Separately, Central Command said the US military and Saudi Arabian forces conducted joint strikes against Iran-aligned terrorists in Iraq. Moreover, President Donald Trump issued a fresh warning that the US will return to strong military action, targeting key Iranian infrastructure, if diplomatic efforts do not bring a rapid resolution to the crisis in the Middle East.

This marks a fresh escalation of tensions in the Middle East and triggers a fresh leg up in crude oil prices, reviving inflation fears and bolstering bets for at least one interest rate hike by the Fed in 2026. This marks a significant divergence in comparison to the Bank of Canada's (BoC) dovish bias, which should cap the Canadian Dollar (CAD). Hence, it will be prudent to wait for strong follow-through selling before confirming that the recent USD/CAD recovery from a one-month low has run out of steam.

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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