The USD/CAD pair trades with mild gains near 1.3720 during the Asian trading hours on Tuesday. However, the upside for the pair might be limited, as the Federal Reserve (Fed) uncertainty and worries about another US government shutdown could exert some selling pressure on the US Dollar (USD) against the Canadian Dollar (CAD). The Fed and Bank of Canada (BoC) interest rate decisions will be the highlights later on Wednesday.
The BoC is widely anticipated to leave its key interest rate unchanged at 2.25% at its January meeting on Wednesday as inflation remains within the target range. The US central bank is also expected to stand pat on Wednesday, although it’s wrestling with different issues, including US President Donald Trump’s attempts to undermine the central bank’s independence and questions about who will replace Jerome Powell as chair when his term ends in May.
Trump said last week that he would soon announce his pick for the next Fed chair to replace Chair Jerome. Speculation about the next Fed Chair might weigh on the Greenback as markets expect a nominee who would favor faster interest rate cuts.
The US government is heading for a partial shutdown as the top Democrat in the US Senate, Chuck Schumer, vows to oppose a funding package that includes appropriations for the Department of Homeland Security. Congress faces a January 30 deadline to fund the government or risk a partial government shutdown, which could drag the USD lower against the CAD.
On the other hand, renewed Trump’s tariff threats might cap the upside for the Loonie. Trump on Saturday threatened to slap 100% tariffs on Canadian goods if the country strikes a trade deal with China, raising fears of a renewed trade war.
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.
