Canadian Dollar stays higher as easing safe-haven demand weighs on US Dollar

Middle East diplomacy curbs safe-haven demand for the US Dollar, keeping USD/CAD under pressure.
Falling oil prices could put the commodity-linked Canadian Dollar under considerable pressure.
Strong US economic releases and elevated expectations of a Fed rate increase could underpin the US Dollar.

USD/CAD trades near 1.3970 in Monday’s Asian session. The pair is recovering from a gap lower at the open but remains in negative territory. Demand for the US Dollar (USD) as a safe haven has weakened as diplomatic efforts to end the Middle East conflict continue, although concerns persist over renewed US military action against Iran. For a third consecutive day, Qatari and Iranian officials held talks aimed at securing an agreement to end the war before the US midterm elections.

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Falling oil prices could nevertheless weigh on the commodity-linked Canadian Dollar, limiting the downside for USD/CAD. Crude retreated after OPEC+ agreed to leave December oil production targets unchanged, maintaining required output at September levels. The agreement sets Saudi Arabia’s allocation at 10.478 million barrels per day (bpd), with Russia at 9.949 million bpd and Iraq at 4.431 million bpd.

Rising expectations of a Federal Reserve rate increase could also help the US Dollar recover. Traders assign roughly a 75% probability to a December hike, according to the CME FedWatch Tool. Recent US macroeconomic releases showing a resilient economy and persistent inflation have reinforced those expectations.

Attention is also turning to forthcoming US releases, notably Nonfarm Payrolls (NFP) and the ISM manufacturing and services reports. Several Federal Reserve officials are due to speak during the week, with their comments expected to provide further insight into the central bank’s monetary policy trajectory.

September US PCE: stalled inflation progress reshapes Dollar outlook

The latest US September PCE release “confirms that progress on inflation has stalled.” That is the assessment of strategists at Brown Brothers Harriman. They report that the figures matched consensus: “headline PCE rose 0.5% m/m vs. +0.3% in August to be up 3.6% y/y vs. 3.4% in August,” while “core PCE was up 0.3% m/m vs. 0.3% in August to be up 3.1% y/y vs. 3.0% in August.” Firmer headline and core readings support their assessment that disinflation has lost momentum. This lack of progress on inflation is becoming an increasingly important influence on the Dollar and interest-rate outlook.

Canadian Dollar: key questions answered

Canadian Dollar: the main market drivers

Interest rates set by the Bank of Canada (BoC), oil prices, economic conditions, inflation and the trade balance are the main influences on the Canadian Dollar (CAD). Oil is Canada’s largest export, while the trade balance measures the difference between the value of exports and imports. Investor sentiment also matters. A shift towards riskier assets, known as risk-on, generally supports CAD; a move into safe havens is described as risk-off. Economic conditions in the US are another important influence, as it is Canada’s largest trading partner.

Bank of Canada policy and the Canadian Dollar

By setting the interest rate at which banks can lend to each other, the Bank of Canada (BoC) strongly influences the Canadian Dollar and borrowing rates across the economy. Its primary objective is to keep inflation at 1-3%, raising or lowering interest rates as needed. Relatively high rates generally favour CAD. The Bank of Canada can also alter credit conditions through quantitative easing or tightening. Easing tends to weaken CAD, while tightening tends to support it.

Oil prices and their effect on the Canadian Dollar

As petroleum is Canada’s largest export, changes in oil prices tend to feed through immediately to the Canadian Dollar. Higher oil prices generally lift CAD by increasing aggregate demand for the currency; falling prices typically have the reverse effect. A rise in oil prices also makes a positive trade balance more likely, providing further support for CAD.

Inflation and the Canadian Dollar’s value

Traditionally, inflation was viewed as harmful to a currency because it erodes the value of money. With cross-border capital controls relaxed in modern times, however, the effect has been the opposite. Higher inflation tends to prompt central banks to raise interest rates, drawing capital from global investors seeking attractive returns. Those inflows increase demand for the domestic currency, which in Canada is the Canadian Dollar.

Economic indicators and the Canadian Dollar

Releases of macroeconomic data provide a measure of economic health and can move the Canadian Dollar. GDP, Manufacturing and Services PMIs, employment figures and consumer sentiment surveys all help shape CAD’s direction. A robust economy supports the currency by attracting foreign investment and potentially prompting the Bank of Canada to raise interest rates. Weak economic figures, by contrast, are likely to weigh on CAD.