- USD/CAD edges higher to 1.3735 in Tuesday’s early Asian session.
- The US ISM Manufacturing PMI dropped slightly in June, indicating an ongoing contraction.
- Higher crude oil prices might cap the downside for the commodity-linked Loonie.
The USD/CAD pair gains ground near 1.3735 during the early Asian session on Tuesday. The rebound of the pair is bolstered by the stronger US Dollar (USD) and higher US Treasury bond yields. Nonetheless, the upside of the pair might be limited as supply fears of crude oil in the second half of the year might lift the commodity-linked Loonie. The speech by Federal Reserve (Fed) Chairman Jerome Powell will be in the spotlight on Tuesday.
The cautious stance from Federal Reserve (Fed) officials is likely to underpin the Greenback in the near term. The Fed has kept its benchmark policy rate in the 5.25%-5.5% range since last July, and the policymakers stated that no rate cuts will be appropriate until they gain more confidence that inflation is on a sustainable path to the Fed 2% target.
San Francisco Fed President Mary Daly said on Friday that inflation remains too high, and she expected year-over-year inflation to potentially remain above 2% through the end of 2025. Meanwhile, Fed Governor Lisa Cook noted that she expected inflation to go "sideways" this year, and fall more sharply next year.
About the data, the US Manufacturing Purchasing Managers Index (PMI) for June declined to 48.5 from 48.7 in May. This figure came in weaker than the estimation of 49.1, the Institute for Supply Management (ISM) reported Monday.
On the Loonie front, the Canadian Dollar (CAD) edges lower despite the hotter-than-expected inflation data in May, raising doubts about rate cuts from the Bank of Canada's (BoC). The BoC governor Tiff Macklem warned that the pace of interest rate cuts will likely be “gradual” and each decision will depend on the economic data.
The downside of the Loonie might be capped amid the rise of crude oil prices. The renewed fears of wider Middle East geopolitical tensions and expectations of rising summer fuel demand continue to boost crude oil prices, which might support the commodity-linked CAD as Canada is the major crude oil exporter to the United States.
Canadian Dollar FAQs
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.
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.
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.
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.
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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