Canadian Dollar remains steady as oil prices decline

USD/CAD holds steady as robust US CPI figures lift expectations of a December Fed rate hike.
Expectations of a December Fed rate hike have strengthened following the hot US CPI reading.
Pressure may build on the commodity-linked Canadian Dollar as rising US crude oil inventories weigh on oil prices.

USD/CAD is largely unchanged near 1.4250 in Friday’s Asian session, following two days of advances. Further gains remain possible, however, as lingering inflation concerns and expectations of higher interest rates could underpin the US Dollar (USD). For fresh direction, traders will look to the US October Producer Price Index (PPI) report due later on Friday.

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Expectations of a December Fed rate hike have firmed after US Consumer Price Index (CPI) inflation figures released earlier this week exceeded forecasts. According to Fed Governor Christopher Waller, a 50-basis-point rate hike should be considered if core inflation stays elevated.

The probability markets assign to a 50-basis-point hike now stands at 14.5%, compared with zero ahead of Tuesday’s inflation release. Friday’s US PPI report will be in focus for additional signals on inflation and the US central bank’s interest rate decision. Forecasts point to a 6.6% YoY increase in headline PPI for October and a 5.0% YoY rise in core PPI over the same reporting period.

Lower oil prices could also support USD/CAD by putting pressure on the commodity-linked Canadian Dollar (CAD). With US crude oil inventories increasing, West Texas Intermediate (WTI) oil prices are losing momentum.

Concerns over excess supply have intensified following last week’s sharp build-up in US crude oil stocks. Energy Information Administration (EIA) figures show that inventories increased by 9 million barrels in the week ending 5 November, reversing a decline of 5.267 million barrels the week before. Markets had expected stocks to fall by 1 million barrels.

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TD Securities sees further scope for selective US Dollar outperformance. Its analysts observe that “across global major currencies, we see room for the USD to rally selectively against CAD and KRW in the near-term.” In their assessment, “diverging employment data releases will likely keep USDCAD supported above 1.40,” because a “rising unemployment rate amid falling wage growth rate in Canada also reduces the market pricing of a December BoC rate hike relative to the Fed.”

Canadian Dollar: Frequently asked questions

Which factors matter most for the Canadian Dollar?

Several key influences shape the Canadian Dollar (CAD): interest rates set by the Bank of Canada (BoC), prices of oil, Canada’s largest export, economic conditions, inflation and the trade balance. The trade balance measures the difference between the value of Canadian exports and imports. Investor sentiment also matters. A willingness to hold riskier assets, known as risk-on sentiment, supports the CAD, while a preference for safe havens is described as risk-off. Conditions in the US economy are another important influence on the Canadian Dollar, as the US is Canada’s largest trading partner.

How does Bank of Canada policy affect the Canadian Dollar?

By determining the interest rate at which banks can lend to each other, the Bank of Canada (BoC) shapes borrowing rates across the economy and significantly influences the Canadian Dollar. Its primary objective is to keep inflation within 1-3%, raising or lowering interest rates as needed. Relatively high rates generally support the CAD. Credit conditions can also be influenced through quantitative easing or quantitative tightening: easing is negative for the CAD, while tightening is positive.

Why do oil price movements affect the Canadian Dollar?

As petroleum is Canada’s largest export, changes in oil prices tend to have an immediate effect on the Canadian Dollar, making oil a major driver of the currency’s value. A rise in oil prices generally lifts the CAD by increasing overall demand for the currency; a fall tends to have the reverse effect. Costlier oil also increases the likelihood of a positive trade balance, providing further support for the CAD.

How do inflation figures affect the Canadian Dollar’s value?

Inflation was traditionally viewed as detrimental to a currency because it erodes the value of money. In modern times, however, the easing of restrictions on cross-border capital flows has reversed that relationship. When inflation rises, central banks tend to increase interest rates, drawing more capital from global investors looking for attractive returns. Demand for the domestic currency consequently rises, which in Canada means greater demand for the Canadian Dollar.

What role do economic releases play in Canadian Dollar movements?

The Canadian Dollar can respond to macroeconomic releases because these provide a measure of economic health. GDP, Manufacturing and Services PMIs, employment figures and consumer sentiment surveys can all shape the CAD’s direction. Economic strength supports the Canadian Dollar by attracting more foreign investment and potentially prompting the Bank of Canada to raise interest rates, strengthening the currency. Weak economic readings, by contrast, are likely to weigh on the CAD.