• USD/CAD edges lower despite a still uncertain geopolitical backdrop.
• A softer US Dollar limits the pair’s upside potential in the short term.
• Rising energy prices strengthen Canada’s inflation outlook.

USD/CAD trades around 1.3685 on Friday, down 0.12% on the day, as the pullback in the US Dollar (USD) dominates price action despite a still fragile geopolitical environment. The US Dollar Index (DXY) loses 0.17% to 98.65, reflecting an easing in market sentiment following signs of de-escalation in tensions between the United States (US) and Iran.

Iran's foreign minister Seyed Abbas Araghchi will reach Islamabad on Friday along with a small delegation for the second round of peace talks with the United States, Al Arabiya reported.

This relative calm reduces demand for safe-haven assets, weighing on the Greenback, while risk-sensitive assets regain some support. Hopes for renewed diplomatic talks are helping improve overall sentiment, although risks related to the Strait of Hormuz and energy flows remain in place.

In this context, the Canadian Dollar (CAD) benefited indirectly from higher energy prices, a key driver for the Canadian economy. According to TD Securities analysts, the Bank of Canada (BoC) is expected to incorporate significantly higher Oil price assumptions in its upcoming Monetary Policy Report, with West Texas Intermediate (WTI) US Oil projected around $85. This would mark a sharp increase from previous estimates and could drive a temporary rise in inflation toward 3% in the second quarter of the year.

On the monetary policy front, the Federal Reserve (Fed) is expected to maintain a cautious stance in the near term, according to Commerzbank, keeping rates unchanged within the 3.50%-3.75% range. However, rate cuts are still anticipated later in the year, which could continue to weigh on the US Dollar.

Finally, Scotiabank analysts note that the bearish structure in USD/CAD remains intact, limiting rebound attempts. The absence of a significant escalation in market tensions and stretched US Dollar valuations could cap any meaningful upside in the pair in the short term, as Canadian fundamentals gradually improve.