USD/CAD weakens below 1.3900 as USD slumps on Fed independence worries

USD/CAD kicks off the new week on a weaker note amid a broad-based USD weakness.
Concerns about the Fed’s independence weigh on the USD despite reduced rate cut bets.
Retreating Oil prices and diminishing odds for a tighter BoC policy might cap the Loonie.

Haresh Menghani FXStreet

The USD/CAD pair attracts some selling at the start of a new week, snapping a nine-day winning streak to its highest level since December 5, around the 1.3920 region, touched on Friday. The intraday slide is sponsored by a broad-based US Dollar (USD) weakness and drags spot prices back below the 200-day Simple Moving Average (SMA) in the last hour.

Federal Reserve (Fed) Chair Jerome Powell said that the threat of criminal charges is a consequence of the central bank setting interest rates based on the best assessment of what will serve the public, rather than following the preference of the President. This adds to concerns about the Fed's independence and its ability to operate free from political interference, which drags the USD away from its highest level since December 5, touched on Friday, and exerts downward pressure on the USD/CAD pair.

Meanwhile, US President Donald Trump said on Sunday that he was considering a range of responses to the unrest sweeping Iran, including potential military action. This comes on top of the protracted Russia-Ukraine war and keeps geopolitical risks in play. This, along with reduced bets for more aggressive policy easing by the Fed, could act as a tailwind for the USD. Apart from this, an intraday pullback in Crude Oil prices could undermine the commodity-linked Loonie and support the USD/CAD pair.

The Canadian Dollar (CAD) is further pressured by signs of weakening domestic labour market conditions, which temper bets for a tighter Bank of Canada (BoC) policy. In contrast, the closely-watched US Nonfarm Payrolls (NFP) report showed on Friday that the Unemployment Rate slipped to 4.4% in December and eased concerns about the labor market report, building the case for the Fed to keep rates higher for longer. This could help limit deeper USD losses and warrants caution for the USD/CAD bears.

Traders might also opt to move to the sidelines ahead of the latest US inflation figures – the Consumer Price Index (CPI) and the Producer Price Index (PPI) on Tuesday and Wednesday, respectively. This, in turn, makes it prudent to wait for strong follow-through selling before confirming that the USD/CAD pair has topped out in the near-term and positioning for any meaningful corrective decline.

Fed FAQs

What does the Federal Reserve do, how does it impact the US Dollar?

Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.

How often does the Fed hold monetary policy meetings?

The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.

What is Quantitative Easing (QE) and how does it impact USD?

In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.

What is Quantitative Tightening (QT) and how does it impact the US Dollar?

Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.

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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