Oil price rebound lifts Canadian Dollar as USD/CAD eases

Crude oil has recovered towards $95.80 per barrel. The rebound supports the commodity-linked Canadian Dollar against the US Dollar, pushing USD/CAD lower.
Immediate geopolitical concerns in energy markets are easing as US-Iran diplomatic talks continue with Qatari mediation.
Uncertainty surrounding the US midterm elections and demand for safe-haven assets continue to cushion the USD against broader losses.

USD/CAD is trading near 1.3990. The pair has edged down during Tuesday’s Asian session, reversing direction after the previous day’s modest rise. A slight recovery in crude oil is supporting the Canadian Dollar (CAD) and weighing on the pair. As the largest crude oil exporter to the United States (US), Canada has a currency closely linked to energy markets. West Texas Intermediate (WTI) crude is trading around $95.80 per barrel, recovering some of the nearly 7% lost in the preceding session.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Geopolitical developments nevertheless continue to cap oil’s potential upside. Iran’s confirmation that indirect talks with the United States remain in progress could put further pressure on crude prices. The discussions seek to end their eight-month conflict. Several days of negotiations involving Iranian officials and Qatari mediators produced revised proposals, but no major breakthrough.

Further progress now hinges on political decisions in Washington, according to Iranian Foreign Minister Abbas Araqchi. He said consultations remained intensive and Iran had presented its conditions. US President Donald Trump had previously signalled that he would hold off on military action against Iran until after the midterm elections.

The broader economic backdrop is also being shaped by US political developments. With American voters going to the polls for the midterm elections, high energy prices are increasing pressure on the Trump administration and the Republican Party. Polls currently favour Democrats to secure the House of Representatives, but the contest for control of the Senate remains tight.

Safe-haven demand for the US Dollar amid election uncertainty may restrict further declines in USD/CAD, even as the Canadian Dollar finds support. The midterms have prompted concerns that inflation and deficits could return to the fore. Interest rate expectations have shifted slightly as a result. The CME FedWatch Tool now puts the probability of a US Federal Reserve rate hike in December at roughly 73%, compared with 80% a week earlier.

Dollar and yields ease on Fed patience and AI growth concerns

According to Brown Brothers Harriman strategists, 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.” As an additional driver, they cite “concerns about an AI investment slowdown compounded the move, casting doubt on the US growth outlook and dampening Fed rate hike expectations.”

US Dollar: Key Questions

What role does the US Dollar play?

As the official currency of the United States of America, the US Dollar (USD) also serves as the ‘de facto’ currency in a significant number of other countries, circulating alongside domestic banknotes. No other currency is traded more heavily. Based on 2022 data, it accounts for over 88% of worldwide foreign exchange turnover, equivalent to average daily transactions of $6.6 trillion. After the Second World War, the USD replaced the British Pound as the world’s reserve currency. Gold backed the US Dollar for most of its history, until the Bretton Woods Agreement in 1971 brought the Gold Standard to an end.

How does Federal Reserve policy affect the US Dollar?

Monetary policy set by the Federal Reserve (Fed) is the single biggest influence on the US Dollar’s value. The Fed’s two mandates are price stability, meaning control of inflation, and full employment. Adjusting interest rates is its main means of pursuing both objectives. If prices rise too rapidly and inflation exceeds the Fed’s 2% target, the central bank raises rates, supporting the USD. Conversely, inflation below 2% or an excessively high Unemployment Rate may prompt the Fed to cut rates, putting pressure on the Greenback.

How does Quantitative Easing affect the US Dollar?

The Federal Reserve can respond to extreme conditions by printing additional Dollars and introducing quantitative easing (QE). Through QE, the Fed substantially expands credit flows in a financial system that has become blocked. This unconventional policy is deployed when credit dries up as banks, fearing counterparty defaults, refuse to lend to one another. It is a last resort when interest rate cuts alone are unlikely to deliver the required outcome. During the Great Financial Crisis in 2008, the Fed chose QE to tackle the credit crunch. The process entails printing more Dollars to purchase US government bonds, primarily from financial institutions. The US Dollar typically weakens as a result of QE.

How does Quantitative Tightening affect the US Dollar?

In the reverse process, known as quantitative tightening (QT), the Federal Reserve halts bond purchases from financial institutions. It also refrains from reinvesting the principal repaid on maturing bonds in further purchases. QT generally supports the US Dollar.