Canadian Dollar edges lower as rising US inflation bolster Fed rate hike outlook
- USD/CAD drifts higher to near 1.3750 in Monday’s early European session.
- Rising US inflation linked to the Middle East conflict reinforced expectations that the Fed could raise rates later this year.
- Trump is set to discuss military options on Iran on Tuesday.
The USD/CAD pair edges higher to around 1.3750 during the early European trading hours on Monday. The US Dollar (USD) extends its upside against the Canadian Dollar (CAD) as traders have largely priced out US interest rate cuts this year, while expectations for a hike have risen.
Hotter-than-expected US inflation data released last week has fueled expectations that the US Federal Reserve (Fed) will keep interest rates elevated. Financial markets are now pricing in nearly a 48.4% probability the US central bank could hike rates by at least 25 basis points (bps) at its December meeting, compared with 14.3% a week ago, according to the CME FedWatch tool.
US President Donald Trump warned that Iran must act "fast" after efforts to end the US-Israeli war with Iran appeared to have stalled. Ongoing tensions between the US and Iran might continue to boost crude oil prices, underpining the commodity-linked Loonie. It is worth noting that Canada is a major oil-exporting country, and higher crude oil prices generally have a positive impact on the Canadian Dollar (CAD).
Reuters reported on Monday that Trump is expected to hold a Situation Room meeting on Tuesday with his top national security advisers to discuss the options for military action regarding Iran.
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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