Canadian Dollar Firms as Improved Risk Sentiment Pressures USD/CAD

Key Moments

Risk-On Tone Supports CAD as USD/CAD Pulls Back

USD/CAD is edging lower around the 1.4100 level during Asian trading on Thursday, pausing after five straight sessions of gains. The pair is under pressure as the US Dollar (USD) softens amid reduced safe-haven demand.

The shift in sentiment follows a BBC report late Wednesday stating that the White House confirmed US President Donald Trump and Iranian President Masoud Pezeshkian signed a preliminary memorandum of understanding aimed at ending the US-Israel war on Iran. According to the report, this executive move came after an earlier electronic signature of an initial framework by US Vice President JD Vance and Iranian Parliamentary Speaker Mohammad Bagher Ghalibaf earlier in the week.

Fed Policy Outlook May Cushion US Dollar

Despite the latest pullback, USD/CAD could find support if the US Dollar rebounds on expectations of additional Federal Reserve interest rate increases later this year. The Federal Reserve’s June Summary of Economic Projections indicated that half of Federal Open Market Committee (FOMC) participants anticipate at least one rate hike in the current year.

Ongoing economic disruptions tied to the conflict in Iran have not prevented firm labor market readings and persistent underlying inflation measures from maintaining pressure for further policy tightening.

The FOMC voted unanimously to keep the benchmark federal funds rate in a 3.5% to 3.75% range. At his first meeting as the new Chair of the US central bank, Kevin Warsh pledged to act forcefully to restore price stability.

Oil Prices Lend Support to the Canadian Dollar

The Canadian Dollar (CAD), often influenced by commodity trends, is also benefitting from firm crude prices. West Texas Intermediate (WTI) is holding gains near $75.10 per barrel at the time of writing, offering additional backing to the currency.

However, crude benchmarks could encounter headwinds if Middle East tensions continue to ease and supply worries diminish. Rising expectations of further Fed rate hikes by the end of 2026 may also weigh on oil demand prospects, tempering support for the CAD.

Fundamental Drivers of the Canadian Dollar

The Canadian Dollar is influenced by several core macroeconomic and market variables, including interest rates set by the Bank of Canada (BoC), oil prices, domestic economic performance, inflation dynamics, and Canada’s trade balance. Market sentiment also plays a role: risk-on conditions tend to be supportive for the CAD, while risk-off episodes generally favor safe-haven currencies. Given the close economic relationship with the United States, developments in the US economy are also a critical factor for CAD movements.

Bank of Canada Policy and Its Impact on CAD

The BoC exerts meaningful influence over the Canadian Dollar through its policy rate, which determines the cost of interbank lending and shapes borrowing costs across the economy. The BoC targets inflation within a 1% to 3% band by raising or lowering interest rates as needed. Relatively higher interest rates are typically positive for the CAD.

The central bank can also deploy quantitative easing or tightening to affect financial conditions. Quantitative easing generally puts downward pressure on the currency, while quantitative tightening tends to be supportive.

Oil Prices and the Canadian Dollar

Oil is Canada’s largest export, making crude price movements a key driver of CAD performance. When oil prices rise, demand for Canadian exports – and by extension the Canadian Dollar – tends to increase, often strengthening the currency. Conversely, declines in oil prices can weigh on CAD.

Higher crude prices can also improve Canada’s trade balance, providing an additional tailwind for the currency.

Inflation, Economic Data, and Currency Response

In the current environment of open capital flows, higher inflation often leads markets to expect central bank rate hikes, which can attract foreign investment seeking higher yields. This can support the Canadian Dollar when domestic inflation trends higher and prompts a more hawkish BoC stance.

Broader macroeconomic releases – including GDP, Manufacturing and Services PMIs, labor market data, and consumer sentiment surveys – also shape expectations for growth, policy, and currency performance. Strong data tends to bolster the CAD by drawing in capital and potentially encouraging tighter monetary policy, while weak data can have the opposite effect.