The USD/CAD pair attracts some buyers for the third consecutive day on Monday and trades just below mid-1.3900s during the Asian session, well within striking distance of a nearly four-month high set last week amid a firmer US Dollar (USD). The uptick, however, lacks bullish conviction as elevated Crude Oil prices could underpin the commodity-linked Loonie and cap gains for spot prices.
US President Donald Trump threatened to target Iran’s power plants and bridges if the Strait of Hormuz is not reopened by Tuesday, while Iran introduced new conditions for reopening the strategic waterway. This raises the risk of a further escalation of the ongoing conflict in the Middle East and continues to underpin the USD’s status as the global reserve currency. Adding to this, rising bets for an interest rate hike by the US Federal Reserve (Fed) turn out to be another factor supporting the USD and acting as a tailwind for the USD/CAD pair.
The closely-watched US Nonfarm Payrolls (NFP) report showed on Friday that the US economy added 178K new jobs in March, reversing the previous month’s revised net loss of 133K. Adding to this, the Unemployment Rate unexpectedly fell to 4.3% last month. This comes on top of inflation fears stemming from the war-driven surge in Crude Oil prices and removes any near-term pressure on the Fed to cut rates, which remains supportive of elevated US Treasury bond yields. The outlook, in turn, continues to support the USD and the USD/CAD pair.
Meanwhile, supply disruption worries lift Crude Oil prices to a nearly four-week top. This might hold back traders from placing aggressive bearish bets around the Canadian Dollar (CAD) and warrants some caution before positioning for any further move higher for the USD/CAD pair. Hence, it will be prudent to wait for a sustained strength and acceptance above the 1.3900 mark, or the year-to-date high, before positioning for an extension of a nearly one-month-old uptrend from the 1.3525 region, or the March monthly swing low.
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.
