Canadian Dollar weakens despite easing risk aversion

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USD/CAD extends its gains for the second successive day, trading around 1.3980 during the Asian hours on Friday. However, the upside for the USD/CAD pair may face notable resistance as a sudden easing of geopolitical risk could sideline the US Dollar (USD).

USD/CAD could struggle if sudden drops in geopolitical risks sideline the safe-haven US Dollar.
President Trump signaled a weekend Iran peace deal after canceling planned US military strikes on their energy infrastructure.
The US Dollar remains strong, backed by hot PPI inflation data.

US President Donald Trump indicated that a peace agreement with Iran could be finalized as early as this weekend, a significant diplomatic pivot following his recent decision to delay planned military strikes on Iran's energy infrastructure. While a final text awaits official approval from both nations, Iran’s semi-official Fars news agency reported that Tehran is likely to accept the terms. According to Trump, the deal would safely reopen vital shipping lanes in the critical Strait of Hormuz and include firm commitments from Iran to abandon its nuclear weapons program.

However, this diplomatic breakthrough simultaneously pressured crude oil prices downward. Because the Canadian Dollar (CAD) is heavily commodity-linked, falling oil prices weakened the CAD, which counterbalanced the USD's weakness and effectively put a floor under the USD/CAD pair to keep it higher.

Meanwhile, underlying support for the Greenback remains robust following hot inflation data released by the US Bureau of Labor Statistics on Thursday. The US Producer Price Index (PPI) surged 6.5% YoY in May, up from 5.7% in April, beating the 6.4% market consensus to register its highest level since November 2022. On a monthly basis, the PPI jumped 1.1% against the market expectation of 0.7%.

This report has strongly reinforced a "higher for longer" interest rate stance from the US Federal Reserve (Fed), which could lift the Greenback in the near term. Commenting on the data, John Ryding, chief economic advisor at Brean Capital, noted that the Fed is clearly missing its inflation target by a lot more than it is missing its employment objective. Ryding added that the scorching PPI report should further embolden those on the FOMC who believe another rate hike might be required later in the year.

Canadian Dollar FAQs

What key factors drive the Canadian Dollar?

The key factors driving the Canadian Dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of Oil, Canada’s largest export, the health of its economy, inflation and the Trade Balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – with risk-on being CAD-positive. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian Dollar.

How do the decisions of the Bank of Canada impact the Canadian Dollar?

The Bank of Canada (BoC) has a significant influence on the Canadian Dollar by setting the level of interest rates that banks can lend to one another. This influences the level of interest rates for everyone. The main goal of the BoC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former CAD-negative and the latter CAD-positive.

How does the price of Oil impact the Canadian Dollar?

The price of Oil is a key factor impacting the value of the Canadian Dollar. Petroleum is Canada’s biggest export, so Oil price tends to have an immediate impact on the CAD value. Generally, if Oil price rises CAD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Oil falls. Higher Oil prices also tend to result in a greater likelihood of a positive Trade Balance, which is also supportive of the CAD.

How does inflation data impact the value of the Canadian Dollar?

While inflation had always traditionally been thought of as a negative factor for a currency since it lowers the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to lead central banks to put up interest rates which attracts more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in Canada’s case is the Canadian Dollar.

How does economic data influence the value of the Canadian Dollar?

Macroeconomic data releases gauge the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment but it may encourage the Bank of Canada to put up interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.