Canadian Dollar strengthens as US Dollar decline despite hawkish Fed outlook

USD/CAD loses ground as the US Dollar weakens despite rising expectations of later Fed rate hikes.
CME FedWatch tool indicates that markets are now pricing in an 83.1% probability of rate hikes by the end of December.
The Canadian Dollar struggles as easing US-Iran tensions cool the global oil market.

Akhtar Faruqui FXStreet

USD/CAD halts its winning streak that began on June 10, trading around 1.4230 during the Asian hours on Thursday. The currency pair depreciate as the US Dollar (USD) declines despite rising market expectations of Federal Reserve (Fed) interest rate hikes later this year.

Traders are positioning for tighter monetary policy after Federal Reserve Chairman Kevin Warsh signaled a firm focus on taming inflation, noting that the broader economy remains on a stable footing. Reflecting this hawkish shift, the CME FedWatch tool shows that markets are now pricing in an 83.1% probability of rate hikes by the end of December.

Traders focus now shifts to the upcoming US Personal Consumption Expenditures (PCE) data release, where headline inflation is expected to heat up to 4.1% YoY in May from April's 3.8%, and core PCE is projected to edge higher to 3.4% YoY.

The commodity-linked Canadian Dollar (CAD) is struggling against its US counterpart as easing geopolitical tensions between the US and Iran cool the global oil market. Lower crude prices directly hit the Canadian economy, as Canada is the largest exporter of crude oil to the United States.

Global oil supplies are rapidly improving following breakthrough progress in US-Iran peace efforts, which has restored shipping confidence and encouraged tankers to transit the critical Strait of Hormuz with their tracking signals activated.

Underscoring this supply surge, US Energy Secretary Chris Wright stated at the Reuters Global Energy Forum in New York that roughly 20 million barrels of oil exited the Strait within a single 24-hour window, marking a clear return to normal operational flows.

Shipping data confirms this rebound, showing that three previously stranded tankers carrying 5 million barrels of crude finally exited the Gulf on Wednesday under the interim diplomatic deal. Available supply is expected to expand even further due to a temporary US waiver that permits the purchase of already-loaded Iranian oil.

Compounding the pressure on the Canadian Dollar, Canada’s 10-year government bond yield fell to a three-month low of 3.36% in late June, as signs of cooling underlying domestic inflation reinforce expectations that the Bank of Canada (BoC) will refrain from raising interest rates for the rest of the year.

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

Akhtar Faruqui

FXStreet

Akhtar Faruqui is a Forex Analyst based in New Delhi, India. With a keen eye for market trends and a passion for dissecting complex financial dynamics, he is dedicated to delivering accurate and insightful Forex news and analysis.

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