USD/CAD consolidates below mid-1.3800s, bullish potential seems intact

• USD/CAD bulls take a breather after the recent runup to the highest level since August 6.
• The recent upswing in the USD acts as a tailwind for the pair amid a downtick in Oil prices.
• Bets for a larger BoC rate cut support prospects for a further near-term appreciating move.

The USD/CAD pair oscillates in a narrow band around the 1.3830 region during the Asian session on Tuesday and remains well within the striking distance of its highest level since August 6 touched the previous day. Meanwhile, the fundamental backdrop seems tilted in favor of bullish traders and suggests that the path of least resistance for spot prices remains to the upside. 

Crude Oil prices struggle to capitalize on the previous day's modest gains amid concerns over slowing demand and a prolonged economic downturn in China – the world's top importer. Apart from this, bets for a larger, 50 bps rate cut by the Bank of Canada, bolstered by softer domestic consumer inflation figures, might continue to undermine the commodity-linked Loonie. This, along with the underlying strong bullish sentiment surrounding the US Dollar (USD), validates the near-term positive outlook for the USD/CAD pair. 

The incoming upbeat US macro data suggested that the economy remains on a strong footing, which should allow the Federal Reserve (Fed) to be patient in cutting interest rates. Moreover, the recent comments by a slew of influential FOMC members reaffirmed market expectations for a less aggressive policy easing by the US central bank. This, in turn, pushes the US Treasury bond yields and the USD Index (DXY), which tracks the Greenback against a basket of currencies, to their highest level in almost three months.

Furthermore, a turnaround in the global risk sentiment – as depicted by a softer tone around the equity markets – should continue to benefit the safe-haven buck and support prospects for a further appreciating move for the USD/CAD pair. Traders now look forward to the release of the Richmond Manufacturing Index from the US, which, along with a speech by Philadelphia Fed President Patrick Harker, will drive the USD demand. Apart from this, Oil price dynamics should provide some impetus to the USD/CAD pair.

Canadian Dollar FAQs

What key factors drive the Canadian Dollar?

The key factors driving the Canadian Dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of Oil, Canada’s largest export, the health of its economy, inflation and the Trade Balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – with risk-on being CAD-positive. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian Dollar.

How do the decisions of the Bank of Canada impact the Canadian Dollar?

The Bank of Canada (BoC) has a significant influence on the Canadian Dollar by setting the level of interest rates that banks can lend to one another. This influences the level of interest rates for everyone. The main goal of the BoC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former CAD-negative and the latter CAD-positive.

How does the price of Oil impact the Canadian Dollar?

The price of Oil is a key factor impacting the value of the Canadian Dollar. Petroleum is Canada’s biggest export, so Oil price tends to have an immediate impact on the CAD value. Generally, if Oil price rises CAD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Oil falls. Higher Oil prices also tend to result in a greater likelihood of a positive Trade Balance, which is also supportive of the CAD.

How does inflation data impact the value of the Canadian Dollar?

While inflation had always traditionally been thought of as a negative factor for a currency since it lowers the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to lead central banks to put up interest rates which attracts more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in Canada’s case is the Canadian Dollar.

How does economic data influence the value of the Canadian Dollar?

Macroeconomic data releases gauge the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment but it may encourage the Bank of Canada to put up interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.

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