Canadian Dollar Firms as Post-Election USD Slide Weighs

Key Moments

USD/CAD Extends Decline After US Election Outcome

USD/CAD is lower for a second straight session, trading around 1.3950 during Asian dealings on Thursday. The pair weakens as the US Dollar faces broad selling following a Democratic sweep in the US midterm elections, which hands control of both chambers of Congress to Democrats and stirs worries over potential political stalemate in Washington.

Expectations that the election results could pave the way for an end to the Middle East conflict have also driven a sharp pullback in oil prices. This slide in crude adds to the downward pressure on the Greenback.

Resilient US Data Supports Fed Rate-Hike Expectations

Despite the recent drop, losses in the US Dollar may be contained as firm US macro data continue to underpin expectations for further Federal Reserve tightening.

Private-sector employment rose by 86,000 in October, according to the ADP report, surpassing the anticipated 69,000 increase. September’s reading, however, was revised down to 86,000 from 90,000. Separately, the ISM Services PMI edged down to 54.5 from 54.9, slightly below the projected 54.8, but still comfortably in expansionary territory.

Data from the CME FedWatch Tool indicate that markets are currently pricing in nearly an 82% probability of another interest rate increase in December. Investors are now focused on upcoming US releases, including weekly Initial Jobless Claims on Thursday and the Nonfarm Payrolls (NFP) report on Friday.

Oil Weakness Caps Canadian Dollar Upside

The downside in USD/CAD may be limited, as the Canadian Dollar – a commodity-linked currency – is itself under pressure from falling oil prices. Canada is one of the largest oil suppliers to the United States, so declines in energy prices tend to directly weigh on the CAD.

Crude Market Responds to Political Shift and Conflict Outlook

Crude oil prices are sliding toward near one-month lows in the wake of the Democratic victory in the US midterm elections. The result has fueled expectations that the incoming Congress will seek to reduce tensions in the military confrontation with Iran.

President Donald Trump acknowledged that Republicans suffered election losses largely due to voter frustration over rising gasoline prices tied to the conflict, while signaling no immediate plans to expand military strikes.

A Congress controlled by Democrats is anticipated to challenge military funding for ongoing Middle East operations. Senate Democratic Leader Chuck Schumer has explicitly pledged to push for an end to the war.

At the same time, crude exports from the Persian Gulf have begun to recover, contributing to a supply backdrop in which available barrels currently outpace near-term demand.

Relative FX Performance: Loonie Trails Higher-Beta Peers

Strategists at Scotiabank note that, although the Canadian Dollar has strengthened recently, it continues to lag behind other major currencies. They observe that the Loonie’s “relative performance is somewhat more underwhelming when compared to its peers, and highlights its role as a lower-beta risk and commodity currency,” emphasizing its tendency to move more cautiously than higher-beta currencies, even when underlying conditions are supportive.

Key Data Points at a Glance

Fundamental Drivers of the Canadian Dollar

The value of the Canadian Dollar is shaped by several core macro and policy variables. These include the Bank of Canada’s (BoC) policy rate, oil prices, domestic economic conditions, inflation, and the trade balance – the gap between the value of Canada’s exports and imports. Broader market sentiment also matters: risk-on conditions tend to favor the CAD, while risk-off environments are typically negative. Given Canada’s close economic ties with the United States, the performance of the US economy is another critical driver.

Bank of Canada Policy and Its Currency Impact

The BoC exerts significant influence on the CAD by setting the benchmark rate at which financial institutions lend to each other, which in turn affects borrowing costs throughout the economy. The central bank’s primary objective is to keep inflation within a 1-3% range by raising or lowering interest rates as needed. Comparatively higher Canadian interest rates are generally supportive of the CAD.

The BoC can also deploy quantitative easing or quantitative tightening to steer credit conditions. Quantitative easing is typically seen as negative for the Canadian Dollar, while quantitative tightening is usually considered supportive.

Oil Prices and the Canadian Dollar

Oil is a central pillar of Canada’s export base, so price swings in crude have a direct and immediate impact on the CAD. When oil prices rise, demand for the Canadian Dollar usually increases, often pushing the currency higher. Conversely, falling oil prices tend to weigh on the CAD. Elevated oil prices also increase the likelihood of a positive trade balance, which can further underpin the currency.

Inflation Dynamics and Currency Valuation

In the current global framework where cross-border capital flows are relatively liberal, higher inflation can paradoxically be supportive for a currency. Rising inflation often prompts central banks to lift interest rates, drawing in foreign capital seeking higher returns. For Canada, this mechanism typically boosts demand for the Canadian Dollar.

Macroeconomic Data and CAD Performance

Regular economic releases provide a snapshot of the Canadian economy’s health and can shift expectations for the CAD. Data on GDP, Manufacturing and Services PMIs, labor market conditions, and consumer sentiment all play a role. Strong readings can bolster the Canadian Dollar by attracting investment and increasing the likelihood of tighter BoC policy, while weaker data tend to have the opposite effect.