Canadian Dollar seems vulnerable as Iran diplomacy hopes weigh on oil prices

USD/CAD sticks to a positive bias for the third straight day – also the tenth in the previous eleven.
The recent decline in oil prices undermines the Loonie and remains supportive amid a bullish USD.
Receding inflation fears keep US bond yields depressed and could act as a headwind for the buck.

Haresh Menghani FXStreet

The USD/CAD pair attracts buyers for the third straight day and trades around the 1.4070-1.4075 area during the Asian session on Wednesday, near its highest level since July 29, touched the previous day. Moreover, the fundamental backdrop supports prospects for an extension of a strong uptrend witnessed over the past two weeks or so.

The recent sharp decline in crude oil prices continues to undermine the commodity-linked Loonie, which, along with a bullish US Dollar (USD) undertone, acts as a tailwind for the USD/CAD pair and validates the constructive outlook. In fact, West Texas Intermediate (WTI) – the benchmark US crude oil – dropped to an over two-week low on Tuesday amid reviving hopes for a diplomatic resolution to end the US-Iran war.

Adding to this, Iran reportedly offered to unblock the Strait of Hormuz in return for a US military de-escalation, further easing supply concerns as Saudi Arabia works to restore a key export route. Meanwhile, sliding oil prices alleviate immediate fears of runaway inflation and keep US bond yields depressed below multi-year highs. This might hold back USD bulls from placing fresh bets and cap the upside for the USD/CAD pair.

However, the USD Index (DXY), which tracks the Greenback against a basket of currencies, remains near its highest level since July 30, set on Tuesday, on the back of the Federal Reserve's (Fed) hawkish outlook. In fact, the US central bank delivered its first interest rate increase in three years and signaled one more hike this year. This, in turn, suggests that the path of least resistance for the buck and the USD/CAD pair remains to the upside.

USD/CAD daily chart

Technical Analysis

The USD/CAD sits above the 38.2% and 50.0% Fibonacci retracement levels and extends its advance after reclaiming the 61.8% retracement. This gives spot prices a bullish near-term bias and back the case for additional gains to the next relevant hurdle at the 78.6% retracement at 1.4137, ahead of the cycle high at 1.4246.

On the downside, initial support is located at the 61.8% retracement at 1.4051, followed by the 50.0% level at 1.3991 and the 38.2% retracement at 1.3931, where buyers could attempt to defend the recent upswing.

(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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