- USD/CAD softens to around 1.4300 in Tuesday’s late American session.
- Canada's annual inflation rate jumped to 2.6% in February, hotter than expected.
- The Fed is anticipated to stay on hold when it concludes its two-day meeting on Wednesday.
The USD/CAD pair loses traction to near 1.4300 during the late American session on Tuesday, pressured by the weaker US Dollar (USD) and lower US yields. Investors will closely monitor the Federal Reserve (Fed) interest rate decision on Wednesday, with no change in rate expected.
The latest Canadian inflation data has added to the challenges faced by the Bank of Canada (BoC). The annual inflation rate, as measured by the change in the Consumer Price Index (CPI), climbed to 2.6% in February from 1.9% in January, Statistics Canada reported on Tuesday. This reading came in hotter than the market expectation of 2.1%.
The CPI rose 1.1% MoM in February, compared to 0.1% in January, hotter than the 0.6% expected. The core CPI, which excludes volatile food and energy prices, rose 0.4% MoM in February, matching January's increase.
Currency swaps put the chance of a pause on interest rate cuts at 59%, according to Reuters, while economists' forecasts are mixed. The Canadian Dollar (CAD) attracts some buyers in an immediate reaction to the hotter inflation data.
The Greenback remains under selling pressure due to fears of an economic slowdown in the United States. The Fed is expected to hold its monetary policy stance at its March meeting on Wednesday amid persistent inflation concerns and heightened economic uncertainty.
Traders will keep an eye on the new economic projections from Fed officials for more cues about the path of US interest rates. Any hawkish comments from the Fed policymakers could lift the USD against the CAD in the near term.
"The SEP (Summary of Economic Projections) will be the most interesting aspect, I imagine, with near-term inflation expectations likely nudged higher, and growth projections marked down a touch, though conviction behind those forecasts is going to be lacking, amid the ever-changing macro outlook," said Michael Brown, senior research strategist at Pepperstone.
Canadian Dollar FAQs
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.
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.
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.
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.
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.
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