CAD Holds Steady as Oil Slide Offsets Softer USD Bid

Key Moments

USD/CAD Under Pressure as Safe-Haven Flows Fade

USD/CAD remains on the back foot, with the pair trading around 1.3970 during Asian hours on Monday after opening with a bearish gap. The move keeps the pair in negative territory as the US Dollar loses support from safe-haven demand. Diplomatic efforts to de-escalate the conflict in the Middle East have reduced some of the immediate flight-to-safety flows into the Greenback, even though concerns persist over the possibility of renewed US military action against Iran.

Officials from Qatar and Iran have been engaged in talks for a third straight day, working toward an agreement aimed at ending the war ahead of the US midterm elections. These continued negotiations are helping to temper risk aversion, limiting upside for the US Dollar and allowing the Canadian Dollar to maintain recent gains against it.

Oil Weakness Caps Canadian Dollar Upside

Despite the softer tone in the US Dollar, losses in USD/CAD are moderated by pressure on the Canadian Dollar stemming from weaker oil prices. As a commodity-linked currency, the CAD often reacts to swings in crude, and the latest decline in oil prices is acting as a counterweight to the retreat in the Greenback.

Crude prices moved lower after OPEC+ agreed to keep December oil production targets unchanged at September levels. The decision maintains current output allocations, with Saudi Arabia’s quota at 10.478 million barrels per day (bpd), Russia’s at 9.949 million bpd, and Iraq’s at 4.431 million bpd.

This steady output stance has helped push crude benchmarks lower, limiting support for the Canadian Dollar and keeping USD/CAD downside in check.

Fed Hike Expectations and Upcoming US Data in Focus

On the policy front, the US Dollar retains a potential source of support from expectations that the Federal Reserve will raise interest rates in December. Data from the CME FedWatch Tool indicate that market participants are pricing in roughly a 75% probability of a rate hike at that meeting. The shift in rate expectations has been underpinned by a series of robust US macroeconomic releases that point to ongoing economic strength and persistent inflation pressures.

Traders are also watching a packed US data calendar. The upcoming Nonfarm Payrolls (NFP) report, along with ISM manufacturing and services surveys, is expected to provide further insight into the state of the US economy. In addition, comments from several Federal Reserve officials scheduled throughout the week are likely to be scrutinized for clues on the future path of monetary policy, which could in turn influence the trajectory of USD/CAD.

PCE Data Reinforces Narrative of Stalled Disinflation

Strategists at Brown Brothers Harriman emphasize that the most recent US September Personal Consumption Expenditures (PCE) inflation figures “confirm that progress on inflation has stalled.” According to their assessment, and in line with consensus expectations, “headline PCE rose 0.5% m/m vs. +0.3% in August to be up 3.6% y/y vs. 3.4% in August,” while “core PCE was up 0.3% m/m vs. 0.3% in August to be up 3.1% y/y vs. 3.0% in August.”

They argue that this combination of stronger headline and core readings supports the view that the earlier disinflation trend has lost traction. This backdrop of stalled inflation progress is becoming an increasingly important element in shaping both the US Dollar narrative and expectations for interest rate markets.

Fundamental Drivers of the Canadian Dollar

The Canadian Dollar (CAD) is influenced by a range of macroeconomic and market factors. Key among them is the interest rate stance of the Bank of Canada (BoC), movements in oil prices, the health of the domestic and US economies, inflation trends, and Canada’s trade dynamics.

Bank of Canada Policy and Its Impact on CAD

The Bank of Canada plays a central role in determining the trajectory of the Canadian Dollar through its control of benchmark interest rates, which guide the rates at which banks lend to each other and, by extension, to households and businesses. The BoC’s primary objective is to keep inflation within a 1-3% range by raising or lowering interest rates as needed.

Generally, relatively higher Canadian interest rates tend to be supportive for the CAD, as they can attract capital inflows from investors seeking higher returns. The BoC also has the option to use quantitative easing or quantitative tightening to adjust financial conditions. Quantitative easing is typically considered negative for the CAD, while quantitative tightening is usually seen as supportive for the currency.

Oil Prices and the Canadian Dollar

Oil price movements are a critical driver of the Canadian Dollar because petroleum is Canada’s largest export. Changes in crude prices can have a swift and direct effect on CAD demand. When oil prices rise, the Canadian Dollar often appreciates, reflecting increased global demand for Canada’s exports. Conversely, falling oil prices generally weigh on the currency.

Higher oil prices also tend to improve Canada’s trade balance – the difference between the value of exports and imports – which can further bolster the Canadian Dollar.

Inflation Dynamics and Currency Valuation

In the current environment of open capital markets, higher inflation does not necessarily undermine a currency. Instead, elevated inflation often prompts central banks to increase interest rates, which can attract foreign capital seeking higher yields. In Canada’s case, such rate hikes can increase demand for the Canadian Dollar and support its value.

Role of Economic Data in CAD Performance

Macroeconomic indicators serve as key barometers for the strength of the Canadian economy and can significantly sway the Canadian Dollar. Data releases such as gross domestic product (GDP), manufacturing and services purchasing managers’ indexes (PMIs), labor market statistics, and consumer sentiment surveys are closely tracked by markets.

Stronger-than-expected economic readings typically benefit the Canadian Dollar by drawing in foreign investment and potentially encouraging the Bank of Canada to adopt a more hawkish policy stance. On the other hand, weaker data tend to pressure the currency lower, as they may signal slower growth and reduce the likelihood of higher interest rates.