CAD Gains as Oil Rally, Fed Shape USD/CAD Trade

Key Moments

USD/CAD Under Pressure as Oil Supports the Loonie

USD/CAD is retreating for the second consecutive day, trading around 1.4200 during Asian market hours on Friday. The move reflects renewed support for the commodity-linked Canadian Dollar (CAD) as crude oil prices advance. Canada is described as a major net exporter of crude oil, with petroleum highlighted as its largest single source of foreign exchange earnings, tying CAD performance closely to energy market dynamics.

Geopolitical Tensions in Strait of Hormuz Lift Crude Oil

Crude oil prices are rising following a suspected projectile attack on a cargo vessel near Oman. The incident abruptly halted United Nations evacuation activities in the strategically important Strait of Hormuz and has reignited concerns over global energy supply security.

Geopolitical risks intensified after Thursday’s market close, when two US officials indicated that Iranian forces had opened fire on the ship as it attempted to pass through the strait. In response, Iranian authorities issued a sharp warning that the safety of vessels traveling outside officially designated Hormuz shipping lanes is no longer assured.

Fed Rate-Hike Expectations Limit USD/CAD Downside

Despite the recent pullback in USD/CAD, downside appears constrained as the US Dollar (USD) is underpinned by expectations of further tightening from the Federal Reserve (Fed). Based on the CME FedWatch tool, market participants have priced in a 63.4% likelihood that the Fed will increase rates at its September 15–16 policy meeting.

This hawkish bias is being driven by accelerating inflation indicators. The headline Personal Consumption Expenditures (PCE) Price Index rose to 4.1% year-over-year in May, compared with 3.3% in April. This marks the first time in three years that the headline measure has moved above 4.0%, a development largely linked in the article to higher energy costs associated with the conflict in the Middle East. These dynamics are keeping the possibility of additional Fed rate hikes later this year in focus.

The Fed’s preferred underlying measure, the core PCE index, increased to 3.4% year-over-year from 3.3% previously, registering its highest annual reading since October 2023. The persistence of core inflation is described as reinforcing support for the US Dollar.

Key Data Points at a Glance

Canadian Dollar: Structural Drivers and Market Sensitivities

The article highlights several fundamental forces that shape the trajectory of the Canadian Dollar. Among the most important are interest rate settings by the Bank of Canada (BoC), oil prices, domestic economic conditions, inflation trends, and the trade balance – defined as the gap between the value of exports and imports. Market risk appetite also plays a role, with risk-on sentiment generally favoring CAD, while risk-off phases tend to be less supportive. Given the close economic relationship between Canada and the United States, developments in the US economy are also described as a major influence on CAD.

Bank of Canada Policy and Its Impact on CAD

The Bank of Canada exerts significant control over CAD through its policy rate, which determines the cost of interbank lending and influences borrowing costs across the economy. The BoC’s primary objective is to keep inflation within a 1-3% range by raising or lowering interest rates as needed. Relatively higher interest rates are characterized as supportive for the Canadian Dollar. The central bank can also deploy quantitative easing or quantitative tightening to affect credit conditions, with easing viewed as negative for CAD and tightening seen as positive.

Oil Prices and the Canadian Dollar

Oil prices are portrayed as a central driver for CAD, given that petroleum is Canada’s largest export. Movements in crude prices tend to have a direct and immediate effect on the currency. The article notes that rising oil prices generally coincide with Canadian Dollar strength, as foreign demand for CAD increases, and that lower oil prices tend to have the opposite effect. Stronger oil prices also help improve the trade balance, providing an additional layer of support for the currency.

Inflation, Economic Data, and Currency Performance

The article explains that, in contemporary markets, higher inflation often leads to higher interest rates as central banks respond, which can attract foreign capital and boost the domestic currency. In Canada’s case, rising inflation that prompts the BoC to tighten policy can therefore be positive for the Canadian Dollar.

Macroeconomic indicators such as GDP, Manufacturing and Services PMIs, labor-market statistics, and consumer sentiment surveys are also cited as important for CAD valuation. Robust data tends to draw more foreign investment and can encourage the BoC to consider raising rates, both of which are generally supportive for the currency. Conversely, weaker economic readings are associated with Canadian Dollar downside.