Commerzbank’s Michael Pfister notes that USD/CAD has surged from below 1.36 to above 1.42 as falling Oil prices and rising Fed hike expectations pressured the Canadian Dollar (CAD). He argues both drivers are overstated, sees no need for actual Fed hikes, and views current USD/CAD levels as exaggerated, implying limited further upside unless significantly negative CAD-specific developments emerge.

Oil and Fed expectations overdone for Loonie

"As recently as the end of April, the outlook was positive for those anticipating a stronger Canadian dollar: thanks to Canadian oil exports and rising oil prices, the CAD emerged as a winner from the Iran conflict and the closure of the Strait of Hormuz, with USD/CAD dropping below 1.36."

"Since peaking in the second half of April, however, the oil price has been falling steadily, and this morning it came close to the pre-war level. The slump in oil prices has put significant pressure on the Canadian dollar."

"By now, only a residual probability of such a move is priced in. But the market is currently pricing in as many as 40 basis points of Fed rate rises by March next year. The upward movement in USD/CAD since early May has thus been almost entirely driven by the shift in interest rate expectations."

"We strongly believe that both of these factors are exaggerated. The oil market appears to be reacting somewhat too euphorically to the reopening of the Strait of Hormuz. It will likely be some time before the world’s depleted stockpiles are replenished and energy trading returns to normal."

"The high USD/CAD levels therefore seem exaggerated to us. This is not to say that there are no reasons for a weaker CAD, such as upcoming USMCA negotiations and a weakening real economy. But given current levels, a great deal would have to happen for USD/CAD to rise further."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)