The USD/CAD pair posts modest losses around 1.3685 during the Asian trading hours on Tuesday. The ongoing conflict in the Middle East provides some support to the commodity-linked Canadian Dollar (CAD) against the US Dollar (USD). The US Federal Reserve (Fed) interest rate decision will take center stage later on Wednesday.
Escalating tensions surrounding the US-Israeli conflict with Iran rattled global markets and pushed oil prices above the $100 per barrel mark. Retaliatory Iranian attacks across the region on ships, infrastructure and ports through which oil tankers transit raise fears of oil supply disruption. It is worth noting that Canada is a major oil-exporting country, and higher crude oil prices generally have a positive impact on the CAD.
Nonetheless, disappointing Canadian employment data could drag the Loonie lower and act as a tailwind for the pair. Canada’s economy unexpectedly lost a net 83,900 jobs in February, while the unemployment rate rose to 6.7% during the same period, according to Statistics Canada data released on Friday.
The Iran war is complicating the outlook for the Fed, which is set to meet on Wednesday for its next interest rate decision. Traders see no chance of a Fed rate reduction at its March policy meeting on Wednesday, from the current range of 3.5% to 3.75%.
Fed Chair Jerome Powell’s remarks after the rate decision will also be in the spotlight. The press conference on Wednesday may be Powell’s second to last, as his term as chair is set to end in May. Any hawkish comments from Powell could help limit the Greenback’s losses in the near term.
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.
