Why is the Canadian Dollar retaining gains despite stalled domestic growth?

Can USD/CAD withstand Canadian Dollar strength driven by higher Oil prices?
August marks a second successive month of stagnation for Canada’s economy.
Further rate increases remain an option for both the BoC and Fed as inflation worries persist.

Selling pressure on USD/CAD persists on Friday as higher Oil prices bolster the commodity-linked Canadian Dollar (CAD), more than offsetting weaker-than-anticipated domestic growth figures. The pair remains under pressure despite the US Dollar (USD) recovering from its earlier losses. At the time of writing, it is trading near 1.3963, the weakest level since mid-September.

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

Concerns over a possible resumption of US military strikes against Iran after next week’s US midterm elections have lifted West Texas Intermediate (WTI) above $103 a barrel, its highest since May. With Canada a major crude exporter, the rise in Oil prices lends support to the Canadian Dollar.

Canada’s economy recorded no growth in August, extending its stagnation to a second successive month, according to Statistics Canada. Monthly Gross Domestic Product (GDP) remained flat against expectations of a 0.2% increase.

For September, preliminary estimates suggest the economy contracted by 0.1%. Weakness in manufacturing and in mining, quarrying, and Oil and gas extraction is estimated to have outweighed improvements in utilities and wholesale trade. This would put third-quarter growth at 0.3% QoQ, equivalent to roughly 1.2% on an annualised basis.

Such an outcome would fall short of the roughly 2% annualised growth projected by the Bank of Canada (BoC) in Wednesday’s monetary policy announcement. At that meeting, the BoC increased its policy rate by 25 basis points (bps) to 2.50%, delivering its first hike since 2023 as Middle East tensions push up energy costs and intensify inflationary pressures.

According to Brown Brothers Harriman, the BoC’s message was clearly hawkish, with the central bank emphasising that “there could be a need to increase the policy rate further.” The bank notes that policymakers “lifted real GDP growth and headline inflation projections across the forecast horizon,” signalling a stronger macroeconomic backdrop than they had previously assumed. Haddad singles out the BoC’s assessment that it now “sees headline CPI above its 2% target through Q4 2028.”

In the US, demand for government bonds following a technology stock sell-off drove Treasury yields lower and weighed on the US Dollar earlier on Friday. Disappointing earnings reports have kept investors uneasy about the returns from heavy AI spending. The Greenback has subsequently recovered, however: after touching 101.59, the US Dollar Index (DXY) has moved back above 102.00.

Expectations of further interest rate increases by the Federal Reserve (Fed) remain supported by resilient US growth and persistent inflation. Although the Fed left rates unchanged at 3.75%-4.00% on Wednesday, September PCE figures showed inflation still running above its 2% target. According to the CME FedWatch Tool, traders assign around a 75% probability to a rate hike in December.

GDP: Common Questions

What does GDP measure, and how is it reported?

Gross Domestic Product (GDP) measures how quickly a country’s economy grows over a specified period, typically a quarter. The most reliable readings compare GDP either with the preceding quarter, such as Q2 of 2023 against Q1 of 2023, or with the corresponding period a year earlier, such as Q2 of 2023 against Q2 of 2022. To calculate annualised quarterly GDP, the quarter’s growth rate is extrapolated on the assumption that it remains unchanged for the rest of the year. This can give a misleading picture when a temporary shock affects one quarter but is unlikely to persist throughout the year. One example was the sharp decline in growth during the first quarter of 2020, when the Covid pandemic began.

Why do GDP readings matter for currencies?

A country’s currency generally benefits from a higher GDP reading. Economic expansion points to a greater likelihood of producing exportable goods and services and drawing in more foreign investment. Conversely, a decline in GDP usually weighs on the currency. As economic activity expands, people typically increase their spending, fuelling inflation. The central bank then needs to raise interest rates to contain price pressures. An accompanying effect is greater capital inflows from international investors, which help the domestic currency appreciate.

Why can stronger GDP weigh on Gold prices?

Economic expansion and rising GDP tend to encourage greater spending, which generates inflation. To curb that inflation, the country’s central bank then needs to increase interest rates. For Gold, higher rates are unfavourable: they raise the opportunity cost of holding the metal rather than keeping the money in a cash deposit account. Faster GDP growth is therefore usually a bearish influence on Gold prices.