Why are a stronger US Dollar and lower oil prices weighing on the Canadian Dollar?

Cautious market sentiment lifts USD/CAD before the Fed and BoC announce their rate decisions.
An October Fed pause carries an 89.5% market-implied probability, with any potential rate hikes pushed back to December.
The commodity-linked Canadian Dollar faces additional pressure as Middle East diplomatic discussions drive crude prices lower.

Caution ahead of Wednesday’s interest rate decisions from the US Federal Reserve (Fed) and the Bank of Canada (BoC) is supporting the US Dollar (USD), lifting USD/CAD for a second consecutive day. During Tuesday’s Asian session, the pair is trading near 1.4020.

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

An October hold followed by a possible December rate hike remains the financial markets’ expectation for the Federal Reserve. The CME FedWatch Tool puts the market-implied probability of unchanged rates at the October policy meeting at 89.5%, while the likelihood of a December increase stands at 82.3%.

Commenting on inflation, Navy Federal Credit Union chief economist Heather Long said, “Inflation is still the No. 1 problem in the US economy, and there are a lot of signs it is getting more broad-based.” She also said, “For consumers, it means really high borrowing costs for the foreseeable future.” On the October decision, however, Heather added, “given that it’s right before an election,” and concluded, “they won’t hike in October.”

Weakness in oil is weighing on the commodity-linked Canadian Dollar (CAD), providing further support to USD/CAD. Renewed Middle East diplomacy has fuelled hopes that a broader escalation of the US-Iran conflict can be averted, sending crude oil prices lower.

Iran, Saudi Arabia, Pakistan, and Turkey agreed on Monday to sustain security talks and strengthen regional cooperation after high-level discussions in Tehran, according to Islamic Republic of Iran Broadcasting (IRIB). The first meeting between Iran and senior officials representing the Mecca Joint Defence Agreement was followed by a joint statement. It said the four countries had agreed to continue dialogue and consultations, especially on regional peace, security, and stability.

Canada’s stance in trade negotiations with the United States (US) remains unchanged, Canadian Prime Minister Mark Carney said on Monday. He attributed any progress to Washington moving closer to Canada’s position.

Is BoC hike risk increasing as markets factor in four moves by 2027?

Recent remarks by Governor Tiff Macklem have substantially altered the policy outlook, according to Commerzbank analysts, who note that “Macklem’s latest comments have significantly increased the risk of an imminent rate hike, and we therefore expect an initial move before the end of this year.” On the near-term outlook, they say that “market participants assign an 85% probability to a rate hike this week, and we also expect a hike given the recent more hawkish comments,” while adding the caveat that “we nevertheless consider such a move due to the subdued core inflation premature.” The scale of the repricing in expectations for the BoC’s policy trajectory is evident further out: Commerzbank notes that “a total of four rate hikes are priced in by September 2027,” highlighting the aggressive shift in market expectations.

Canadian Dollar: Frequently Asked Questions

Which factors have the greatest influence on the Canadian Dollar?

Interest rates determined by the Bank of Canada (BoC), oil prices, economic conditions, inflation and the trade balance are among the main drivers of the Canadian Dollar (CAD). Oil is Canada’s largest export, while the trade balance measures the difference between the value of the country’s exports and imports. Investor sentiment also matters: a willingness to buy riskier assets (risk-on) generally supports the CAD, whereas a preference for safe havens is described as risk-off. Economic conditions in the US are another important influence, given its position as Canada’s largest trading partner.

Why do Bank of Canada decisions matter for the Canadian Dollar?

By determining the interest rate at which banks lend to each other, the Bank of Canada (BoC) influences borrowing rates across the economy and, in turn, the Canadian Dollar. Its primary objective is to keep inflation within 1-3%, raising or lowering interest rates as needed. Comparatively high rates generally support the CAD. Credit conditions can also be influenced through quantitative easing, which is negative for the CAD, or quantitative tightening, which is positive for the currency.

Why is the Canadian Dollar sensitive to oil prices?

As petroleum is Canada’s largest export, movements in oil prices tend to feed directly into the Canadian Dollar’s value. Rising oil prices generally lift overall demand for the currency, supporting the CAD; falling prices usually have the reverse effect. Costlier oil also increases the likelihood of a trade surplus, providing another source of support for the Canadian Dollar.

What does inflation data mean for the Canadian Dollar?

Traditionally, inflation was viewed as detrimental to a currency because it erodes the value of money. With cross-border capital controls relaxed in modern times, however, the effect has actually been the reverse. When inflation rises, central banks tend to raise interest rates, drawing capital from international investors looking for attractive returns. The resulting inflows boost demand for the domestic currency, which, in Canada, is the Canadian Dollar.

How can economic releases move the Canadian Dollar?

The Canadian Dollar can respond to macroeconomic releases because they indicate the economy’s health. GDP, manufacturing and services PMIs, employment figures and consumer sentiment surveys can all shape the CAD’s direction. Economic strength supports the currency by attracting foreign investment and potentially prompting the Bank of Canada to raise interest rates. Weak economic readings, by contrast, are likely to weigh on the CAD.