Canadian Dollar Firms as Oil Jitters Drag USD/CAD Lower

Key Moments

USD/CAD Slides as Oil Rally Lifts Canadian Dollar

USD/CAD extended its decline for the sixth consecutive session, hovering around 1.4040 in Asian trading on Thursday. The pair came under pressure as the Canadian Dollar (CAD) gained ground, supported by a rise in crude oil prices.

Oil rallied after a drone strike on Saudi Aramco’s Shaybah oil field caused two fatalities, intensifying geopolitical tensions in the Middle East and amplifying concerns about potential disruptions to global energy supplies.

Escalating Geopolitical Risks in the Middle East and Eastern Europe

Geopolitical uncertainty deepened following comments from Iranian Foreign Minister Abbas Araghchi on Wednesday. He said the United States must end its naval blockade and demonstrate a genuine commitment to diplomacy. Araghchi reiterated that Tehran is prepared to return to talks if there is clear evidence of a sincere U.S. effort to secure a fair and lasting resolution to the conflict.

At the same time, Ukraine conducted large-scale drone attacks on key Russian oil facilities this week. The operations targeted infrastructure central to Moscow’s planned increase in diesel exports under a recent agreement between Presidents Trump and Putin, signaling Kyiv’s intent to impede those expansion plans.

Fed Policy Uncertainty Weighs on Broader Market Sentiment

Market participants are also focused on the Federal Reserve’s policy outlook ahead of next week’s meeting. Uncertainty remains elevated after Fed Chair Kevin Warsh declined last week to provide guidance on whether additional interest rate increases will be needed or when they might occur.

IMF Growth Outlook Highlights Structural Headwinds for Canada

Strategists at Societe Generale noted that the latest International Monetary Fund projections highlight a less favorable backdrop for Canada relative to the United States. They emphasized that “with the IMF’s US growth forecast revised up to 2.5% this year (while remaining at 2.1% in 2027), the North American growth gap is widening.”

They further observed that “the chart on the right shows relative Bloomberg consensus growth forecasts for 2027, but the IMF’s assessment (1.2% growth in Canada next year versus 2.1% in the US) is even less favourable for Canada,” reinforcing expectations of softer Canadian economic momentum.

Societe Generale also pointed to the interest-rate backdrop, stating that “the chart on the left shows the two-year rate differential plotted against USD/CAD,” underscoring how relative front-end yields continue to shape the Canadian Dollar’s performance against the U.S. Dollar.

Canadian Dollar: Key Fundamental Drivers

The article also outlined several core factors that typically influence the Canadian Dollar’s behavior.

Primary Forces Shaping the Canadian Dollar

The Canadian Dollar (CAD) is heavily influenced by interest-rate policy set by the Bank of Canada (BoC), the price of oil – Canada’s largest export – the overall strength of the domestic economy, inflation dynamics, and the trade balance, defined as the difference between export and import values. Market risk appetite also plays a notable role, as risk-on conditions tend to favor CAD, while risk-off environments generally weigh on it. Given the close economic ties, the health of the U.S. economy is another critical factor for the Canadian currency.

Bank of Canada Policy Channel

The Bank of Canada exerts substantial influence on the CAD through its policy rate, which determines the level at which financial institutions lend to each other and, by extension, the broader interest-rate structure. The BoC’s primary mandate is to maintain inflation in a 1-3% range, adjusting rates higher or lower to achieve this objective. Relatively higher Canadian interest rates tend to be supportive for the CAD.

The BoC can also deploy quantitative easing or quantitative tightening to affect credit conditions. The use of quantitative easing is generally seen as negative for the CAD, while quantitative tightening is typically interpreted as positive.

Oil Prices and the Canadian Dollar

Oil prices are a central driver of the Canadian Dollar, as petroleum is Canada’s largest export. Moves in crude often transmit quickly to the currency: a rise in oil prices typically coincides with CAD appreciation as global demand for Canadian exports and, by extension, its currency, increases. Conversely, falling oil prices usually pressure the CAD.

Higher oil prices can also improve the trade balance by boosting export revenues, providing an additional layer of support for the currency.

Inflation, Macro Data, and CAD Performance

In the current environment of relatively open capital flows, higher inflation can attract capital if it prompts the central bank to raise interest rates. For Canada, elevated inflation may lead the BoC to tighten policy, drawing foreign investors seeking higher yields and thereby increasing demand for the CAD.

Broader macroeconomic indicators also influence the Canadian Dollar. Data releases covering GDP, Manufacturing and Services PMIs, employment conditions, and consumer sentiment help investors gauge economic strength. Robust data tend to support the CAD by encouraging capital inflows and potentially prompting tighter monetary policy. Weak data, in contrast, generally weigh on the currency.