Canadian Dollar falls as US-Canada rate gap seen widening further
- USD/CAD advances as the Canadian Dollar weakens against expectations of a widening US-Canada interest-rate gap.
- US-Canada policy rate differential is expected to widen following the Bank of Canada's September decision to hold rates at 2.25%.
- US Dollar could further advance amid growing market expectations for an October Federal Reserve rate hike.
USD/CAD extends its gains for the sixth consecutive day, trading around 1.4150 during Asian hours on Monday. The pair appreciates as the Canadian Dollar (CAD) is declining under pressure from expectations of a widening interest-rate differential between the United States (US) and Canada. This gap is expected to grow after the Bank of Canada (BoC) kept its key policy rate unchanged at 2.25% at its September meeting.
CAD under pressure as US-Canada spreads loom but move seen as stretched
Strategists at Scotiabank observe that “wider US-Canada spreads have been a major headwind for the CAD over the past couple of weeks,” leaving the currency under pressure against the USD and lagging most of its G10 peers. However, they add that “the move feels somewhat stretched,” arguing that there is “limited scope for further tightening in Fed expectations while the BoC feels somewhat underpriced,” suggesting the recent underperformance of the Canadian Dollar may be overdone.
However, elevated oil prices continue to put upward pressure on Canadian inflation. Traders are looking for fresh catalysts while closely monitoring geopolitical developments in the Middle East. Market sentiment remains tied to the region after US President Donald Trump rejected Iran’s latest proposal to reopen the Strait of Hormuz, stating that Tehran had overplayed its hand, though he noted negotiations are expected to resume this week.
Furthermore, President Trump expressed confidence that the conflict with Iran would conclude soon, while keeping open the possibility of additional military strikes before the midterm elections.
The Federal Reserve (Fed) raised its federal funds target range at its latest meeting, reinforcing the US Dollar's (USD) advantage over the Canadian Dollar. Money markets are now pricing in a 65.9% chance of another benchmark rate hike at the October Fed meeting, up significantly from 57.6% a week ago and just 9.4% a month ago.
Traders are turning their focus toward key economic indicators due this week. Market attention is centered on upcoming US employment data and the Fed’s preferred inflation gauge to gauge the future trajectory of monetary policy.
Last week, Cleveland Fed President Beth Hammack warned against allowing the public to accept elevated prices as the norm. Echoing this sentiment, Philadelphia Fed President Anna Paulson noted that modest further tightening may be warranted.
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.