Canadian Dollar declines as falling crude prices overshadow weaker US Dollar

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USD/CAD gains traction on Wednesday as easing Oil prices pressure the Canadian Dollar, offsetting the impact of a softer US Dollar as traders digest fresh headlines surrounding a potential US-Iran peace deal. At the time of writing, the pair is trading around 1.3834, hovering near six-week highs.

USD/CAD trades near six-week highs as falling Oil prices pressure the commodity-linked Canadian Dollar.
Improving optimism surrounding a potential US-Iran peace deal weighs on the US Dollar and drags crude Oil prices lower.
Traders await US PCE data and Canada’s GDP report for fresh clues on the monetary policy outlook.

Investor sentiment improved after Iran’s State TV reported that Tehran and Washington had prepared an initial unofficial framework for a memorandum of understanding (MOU). According to the draft framework, US military forces would withdraw from the vicinity of Iran and lift the naval blockade, while Iran would restore commercial transit through the Strait of Hormuz to pre-war levels within one month.

The report also stated that any final agreement reached within 60 days would be formalized through a binding United Nations Security Council resolution. The headlines weighed on the Greenback, with the US Dollar Index (DXY), which tracks the Greenback's value against a basket of six major currencies, retreating toward the 99.00 mark.

Meanwhile, Oil prices extended their pullback from recent highs, with West Texas Intermediate (WTI) crude falling more than 3.5% to trade around $89 per barrel at the time of writing. The Canadian Dollar is highly sensitive to Oil price movements, given Canada’s status as one of the world’s largest Oil exporters.

However, uncertainty remains over whether a final agreement can be reached, as Iran’s nuclear program remains unresolved, a key demand from Washington in the negotiations. US President Donald Trump is scheduled to hold a cabinet meeting later on Wednesday to discuss the ongoing talks with Iran.

Given the current macroeconomic environment, monetary policy expectations also remain in focus. Despite the recent pullback in crude prices, Oil continues to trade at elevated levels compared to pre-conflict conditions, keeping concerns over Energy-driven inflation alive and reinforcing expectations that major central banks may need to maintain tighter monetary policy for longer.

On the economic data front, the four-week average of the US ADP Employment Change for the week ending May 9 eased to 35.75K from the previous reading of 40.75K.

Traders now await the US Personal Consumption Expenditures (PCE) inflation report on Thursday, followed by Canada’s Gross Domestic Product (GDP) data on Friday.

Inflation FAQs

What is inflation?

Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.

What is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.

What is the impact of inflation on foreign exchange?

Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.

How does inflation influence the price of Gold?

Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.