Canadian Dollar Gains as Oil Rebounds, USD/CAD Retreats

Key Moments

Oil Recovery Lifts CAD, Pressures USD/CAD

USD/CAD is edging lower around 1.3990 in Asian trading on Tuesday, giving back part of the modest advance logged in the previous session. The pair is under pressure as the Canadian Dollar (CAD) finds support from a rebound in crude prices.

Canada is the largest supplier of crude oil to the United States, leaving the CAD closely correlated with energy market moves. West Texas Intermediate (WTI) crude has recovered some of its losses and is trading near $95.80 per barrel after suffering a sharp drop of nearly 7% in the prior session.

Geopolitics and Diplomatic Efforts Cap Oil Upside

Despite the recovery, further appreciation in crude remains constrained by ongoing geopolitical and diplomatic developments. Iran has confirmed that indirect talks with the United States aimed at resolving their eight-month conflict are continuing. These discussions follow several days of meetings between Iranian officials and Qatari mediators, which produced revised proposals but no decisive breakthrough.

Iranian Foreign Minister Abbas Araqchi stated that consultations are still active and that Iran has already laid out its conditions, with additional progress now hinging on political decisions in Washington. At the same time, US President Donald Trump previously signaled that he would avoid military action against Iran ahead of the midterm elections, helping to temper near-term geopolitical risk premia in energy markets.

US Political Landscape Adds to Market Caution

Domestic political dynamics in the United States are also shaping the broader macro backdrop. As voters go to the polls for the midterm elections, the Trump administration and the Republican Party are under intensifying scrutiny over elevated energy prices.

Polling data currently suggest Democrats are favored to capture the House of Representatives, while control of the Senate remains too close to call. This electoral uncertainty is feeding safe-haven demand for the US Dollar, helping to limit the downside in USD/CAD despite the support for the Canadian Dollar from firmer oil.

The midterm vote has revived concerns about potential shifts back toward inflation and deficit challenges. In response, market-based expectations for US monetary policy have adjusted modestly. The CME FedWatch Tool now reflects approximately a 73% probability of a Federal Reserve interest rate increase in December, compared with 80% one week earlier.

Strategist Views: Dollar and Yields Ease

Dollar sentiment has also been influenced by evolving expectations for Federal Reserve policy and the growth outlook. According to strategists at Brown Brothers Harriman, the US currency and front-end Treasury yields weakened recently as policymakers signaled patience on further tightening.

Strategists at Brown Brothers Harriman note that the Dollar and short-term Treasury yields “drifted lower last week as Fed Chair Kevin Warch struck a patient tone despite stalled progress on US inflation.” They add that “concerns about an AI investment slowdown compounded the move, casting doubt on the US growth outlook and dampening Fed rate hike expectations.”

US Dollar Overview and Policy Drivers

The article also provides background on the structure and drivers of the US Dollar.

The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022.
Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.

The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.

In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.

Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.