Canadian Dollar Firms as USD Retreats; Oil Caps Upside

Key Moments

USD/CAD trades just below the mid-1.3900s in the Asian session on Tuesday, down less than 0.05% after touching its highest level since late March.
A pause in Iran-Israel hostilities pressures the safe-haven US Dollar, while weaker Crude Oil prices curb gains for the commodity-linked Canadian Dollar.
Markets price over a 70% probability of a US Federal Reserve rate hike in 2026, with upcoming US CPI and PPI data set to guide expectations.

USD/CAD Pulls Back After Testing Late-March High

The USD/CAD currency pair is edging lower in Asian trading on Tuesday, giving back part of the previous session’s advance that had taken it to its strongest level since late March. The pair is currently trading just under the mid-1.3900s, reflecting a modest daily decline of less than 0.05%. Despite the pullback, selling interest has not been strong enough to trigger a deeper correction at this stage.

Geopolitical De-escalation Weighs on USD, Oil Slump Supports Pair

Sentiment toward risk assets has improved after Iran and Israel announced on Monday that they had stopped attacking each other. This reduction in geopolitical tensions has diminished demand for the safe-haven US Dollar, pulling it back from a two-month high and creating a headwind for USD/CAD.

At the same time, the easing of tensions is pressuring Crude Oil prices. Softer Oil is a negative driver for the Canadian Dollar, which is closely tied to commodity markets. As a result, weaker Oil is helping to contain the downside in USD/CAD, offsetting some of the impact from the softer USD.

Fed Expectations and Middle East Risks Temper Optimism

Despite the improvement in risk appetite, overall market optimism remains constrained. Major disagreements between the United States and Iran over Tehran’s nuclear program and the situation around the Strait of Hormuz continue to cloud the outlook. These unresolved issues are limiting the extent of the risk-on move.

In addition, expectations for a hawkish US Federal Reserve stance are lending support to the Dollar. Traders are currently assigning more than a 70% probability to a Fed rate hike in 2026, a view reinforced by Friday’s stronger-than-expected US employment data. These expectations may discourage aggressive selling of the USD and could underpin USD/CAD going forward.

Focus Turns to US Inflation Data and Oil Dynamics

Market participants are now turning their attention to key US inflation releases. The US Consumer Price Index (CPI) for May is scheduled for Wednesday, followed by the Producer Price Index (PPI) on Thursday. These data points are expected to be pivotal in shaping expectations for the Fed’s future policy path and, in turn, demand for the US Dollar.

Alongside US inflation figures, investors will be closely watching developments in the Middle East and their impact on Oil prices. Movements in Crude Oil are likely to remain an important driver for the Canadian Dollar and could generate additional volatility in USD/CAD.

Canadian Dollar: Core Drivers and Macro Linkages

The Canadian Dollar is influenced by several fundamental factors, including interest rate settings by the Bank of Canada (BoC), Oil prices, domestic economic conditions, inflation, and the country’s Trade Balance. As Canada’s largest export is Oil, fluctuations in energy markets tend to have a direct and often immediate impact on CAD performance.

Factor	Typical Impact on CAD
Bank of Canada interest rates	Relatively higher rates are generally supportive for CAD; lower rates tend to weigh on the currency.
Oil prices	Rising Oil prices typically bolster CAD; falling prices usually pressure the currency.
Inflation	Higher inflation can prompt rate hikes, attracting capital inflows and supporting CAD under modern conditions.
Trade Balance	A stronger export position and positive Trade Balance tend to be CAD-positive.
Risk sentiment	Risk-on environments favor CAD, while risk-off episodes tend to hurt it.
US economic health	As Canada’s largest trading partner, US economic performance is a key external driver of CAD.

Role of the Bank of Canada in CAD Valuation

The Bank of Canada exerts significant influence over the Canadian Dollar through its interest rate policy. By setting the rate at which financial institutions lend to each other, the BoC indirectly shapes borrowing costs across the economy. Its primary objective is to keep inflation within a 1-3% range by adjusting interest rates higher or lower as needed. In general, relatively higher interest rates are supportive for CAD.

The BoC also has the ability to implement quantitative easing or quantitative tightening to alter credit conditions. Quantitative easing is typically viewed as negative for CAD, while quantitative tightening is considered supportive for the currency.

Oil Prices and the Canadian Dollar

Because petroleum is Canada’s most important export, shifts in Oil prices have a pronounced effect on the Canadian Dollar. When Oil prices rise, demand for CAD tends to increase, often pushing the currency higher. Conversely, declines in Oil can weaken CAD as export revenues and demand for the currency fall. Higher Oil prices also increase the likelihood of a stronger Trade Balance, which further supports the currency.

Inflation, Economic Data, and CAD Performance

In the current global environment, higher inflation often leads central banks to raise interest rates. For Canada, such moves can attract foreign capital, boosting demand for the Canadian Dollar. This dynamic has made inflation data an important input for FX market participants.

Broader macroeconomic indicators also play a crucial role. Releases such as GDP, Manufacturing and Services PMIs, employment figures, and consumer sentiment surveys provide insight into the health of the Canadian economy. Strong data can draw additional foreign investment and increase the likelihood of tighter BoC policy, both of which favor CAD. Conversely, weak readings generally weigh on the currency.