USD/CAD drops to near 1.3460 as US Dollar edges lower ahead of inflation test

USD/CAD falls to near 1.3460 with US core PCE inflation and Canadian Q2 GDP data in focus.
The Fed is widely anticipated to start reducing interest rates in September.
Weak Canada GDP data would prompt the BoC to ease monetary policy further.

Sagar Dua FXStreet

The USD/CAD pair falls to near 1.3460 in Thursday’s Asian session. The Loonie asset drops as the US Dollar (USD) struggles to hold Wednesday’s recovery move. The US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, edges lower from 101.18 after a strong recovery from the fresh annual low of 100.50.

The US Dollar is expected to remain on the tenterhooks as investors look for the United States (US) core Personal Consumption Expenditure price index (PCE) data for July, which will be published on Friday. The PCE report is expected to show that year-on-year core inflation rose at a faster pace of 2.7% from 2.6% in June, with monthly figures growing steadily by 0.2%. The inflation data would significantly influence market speculation for the Federal Reserve’s (Fed) September monetary policy.

Currently, financial market participants seem confident that the Fed will start reducing interest rates in September. However, traders remain split over whether the potential size of the rate-cut would be gradual or a hefty one.

According to the CME FedWatch tool, 30-day Federal Funds Futures pricing data shows that the probability of a 50-basis points (bps) interest rate reduction in September is 34.5%, while rest are favoring a cut by 25 bps.

On the Canadian Dollar (CAD) front, investors await the monthly and Q2 Gross Domestic Product (GDP) data, which will be published on Friday. The GDP report is expected to show that the economic barely expanded in June after 0.2% growth in May. On an annualized basis, the Canadian economy is estimated to have grown at a slower pace of 1.6% from the former release of 1.7%. Signs of cooling economic outlook would boost expectations of more interest rate cuts by the Bank of Canada (BoC).

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

Sagar Dua

FXStreet

Sagar Dua is associated with the financial markets from his college days. Along with pursuing post-graduation in Commerce in 2014, he started his markets training with chart analysis.

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