Why is the Canadian Dollar holding steady as hawkish Fed bets stabilise the US Dollar?

USD/CAD could gain ground as stronger US inflation readings and hawkish Fed remarks reinforce expectations of a December Fed rate hike.
The Canadian Dollar faces pressure from weaker crude oil prices as OPEC+ production surges and US-Iran tensions ease.
Downside pressure on the CAD eases as Canadian inflation rises to 3.1%, strengthening expectations of a Bank of Canada rate hike.

After two successive days of gains, USD/CAD is trading largely unchanged near 1.4250 in Thursday's Asian session. The pause may give way to renewed gains, with a more hawkish Federal Reserve (Fed) policy outlook potentially lending support to the US Dollar (USD).

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Expectations of a December rate hike have strengthened following US Consumer Price Index (CPI) inflation figures that exceeded forecasts. Adding to those expectations, Fed Governor Christopher Waller said earlier this week that he would support a quarter-point rise, or even a half-point increase should inflation deteriorate. The CME FedWatch Tool indicates that markets now assign around an 87% probability to a December rate hike, alongside a nearly 13% chance of a larger 50 basis point increase.

TD Securities sees further upside for the US Dollar against selected major currencies. Its analysts state that “across global major currencies, we see room for the USD to rally selectively against CAD and KRW in the near-term.” Pointing to Canada’s “rising unemployment rate amid falling wage growth rate” as a factor weakening the argument for tighter policy, they contend that “diverging employment data releases will likely keep USDCAD supported above 1.40,”. They believe this environment “reduces the market pricing of a December BoC rate hike relative to the Fed,” keeping the Canadian Dollar exposed to weakness and supporting USDCAD at elevated levels.

Weakness in crude oil could provide another lift to USD/CAD by weighing on the commodity-linked Canadian Dollar (CAD). The retreat in oil prices comes as the US and Iran appear to be steering clear of further escalation, alongside an expansion in supply.

OPEC’s monthly report, published on Wednesday, showed that OPEC+ crude output jumped by roughly 2.04 million barrels per day in October to 41.23 million barrels per day. Increased production in Saudi Arabia accounted for much of the rise.

At home, expectations of a possible Bank of Canada (BoC) rate hike are offering the CAD some underlying support. Canada’s annual inflation rate rose slightly from 3.0% in August to 3.1% in September, its highest level since May's 3.2%. Separately, the Democratic Party's win in the US mid-term elections may ease trade-related pressures on Canadian economic growth.

Canadian Dollar: Frequently Asked Questions

Which factors shape the Canadian Dollar’s direction?

Interest rates set by the Bank of Canada (BoC), Oil prices, economic health, inflation and the Trade Balance are among the principal drivers of the Canadian Dollar (CAD). Oil is Canada’s largest export, while the Trade Balance measures the difference between the value of its exports and imports. Investor sentiment matters too: a willingness to buy riskier assets (risk-on) generally supports the CAD, whereas a preference for safe havens signals a risk-off mood. Economic conditions in the US also have a major influence on the Canadian Dollar, given that the US is Canada’s largest trading partner.

Why do Bank of Canada decisions matter for the Canadian Dollar?

By setting the interest rate at which banks can lend to one another, the Bank of Canada (BoC) influences borrowing rates across the economy and, in turn, 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 tightening: easing tends to weigh on the CAD, while tightening tends to strengthen it.

Why is the Canadian Dollar sensitive to Oil prices?

As petroleum is Canada’s largest export, changes in Oil prices tend to affect the Canadian Dollar immediately, making them an important driver of its value. Rising Oil prices generally lift the CAD by increasing overall demand for the currency; falling prices usually have the reverse effect. Costlier Oil also tends to improve the likelihood of a positive Trade Balance, providing further support to the CAD.

Why can inflation figures move the Canadian Dollar?

Inflation was traditionally viewed as a drag on a currency because it erodes the value of money. With cross-border capital controls becoming less restrictive in modern times, however, the effect has often been the opposite. Higher inflation typically prompts central banks to raise interest rates, drawing capital from global investors looking for attractive returns. The resulting inflows increase demand for the domestic currency, which, in Canada, is the Canadian Dollar.

What do economic releases mean for the Canadian Dollar?

By revealing the state of the economy, macroeconomic releases can move the Canadian Dollar. GDP, Manufacturing and Services PMIs, employment figures and consumer sentiment surveys all help shape the CAD’s direction. Economic strength generally supports the currency by attracting foreign investment and potentially prompting the Bank of Canada to raise interest rates. Weak readings, by contrast, are likely to weigh on the CAD.