USD/CAD corrects further from over a two-year high, downside potential seems limited for now

• USD/CAD retreats further from over a two-year high and snaps a five-day winning streak.
• Recovery in oil prices underpins the loonie and exerts pressure amid a modest USD slide.
• Recession fears, aggressive Fed rate hike bets to act as a tailwind for the buck and the pair.

The USD/CAD pair comes under heavy selling pressure on Tuesday and moves further away from levels just above the 1.3800 mark - the highest since June 2020 touched the previous day. The pair, for now, seems to have snapped a five-day winning streak and has fallen below the mid-1.2600s during the early European session.

Crude oil prices stage a modest recovery from a multi-month low amid hurricane-led supply disruptions and underpin the commodity-linked loonie. The US dollar, on the other hand, pauses its recent blowout rally to a two-decade high and turns out to be another factor exerting some downward pressure on the USD/CAD pair.

The risk-on impulse, as depicted by a generally positive tone around the equity markets, prompts some profit-taking around the safe-haven greenback. Apart from this, retreating US Treasury bond yields further seem to weigh on the buck, though a more hawkish stance adopted by the Federal Reserve should help limit losses.

In fact, the US central bank signalled last week that it will likely undertake more aggressive rate hikes at its upcoming meetings to tame inflation. Adding to this, a duo of FOMC members reiterated on Monday that the priority remains controlling domestic inflation. This should act as a tailwind for the US bond yields.

Furthermore, worries that a deeper economic downturn will dent fuel demand should keep a lid on any meaningful upside for oil prices. Apart from this, the risk of a further escalation in the Russia-Ukraine conflict supports prospects for the emergence of some dip-buying around the safe-haven buck and the USD/CAD pair.

From a technical perspective the pullback seen from the 1.3800 peak may mark the end of a bullish exhaustion move. This often happens when price breaks out of a channel in the same direction as it is evolving – in the case of USD/CAD when it broke up out of an already rising channel. This can mark an acceleration in the trend prior to it peaking. It is still a little early to say for sure whether the uptrend has in fact peaked for the loonie, however, traders should be alert to the possibility. Really only price action over the next few days and weeks will determine for sure whether 1.3800 represents an significant intermediate or long-term top or not.

Market participants now look forward to Fed Chair Jerome Powell's speech at an event in Paris, which might influence the USD. Traders will further take cues from the US economic docket - featuring Durable Goods Orders, the Conference Board’s Consumer Confidence Index, New Home Sales and Richmond Manufacturing Index.

This, along with the US bond yields and the broader risk sentiment, will drive the USD demand. Apart from this, oil price dynamics might further contribute to producing short-term trading opportunities. Nevertheless, the fundamental backdrop suggests that the path of least resistance for the USD/CAD pair is to the upside.

Technical levels to watch