USD/CAD weakens below 1.3700 as signs of easing inflation spur Fed rate cut hopes
- USD/CAD edges lower to 1.3675 amid Monday’s Asian session.
- The softer US PCE inflation boosts the Fed rate cut hopes, weighing on the pair.
- Higher crude oil prices continue to underpin the commodity-linked Canadian Dollar.
The USD/CAD pair trades on a softer note around 1.3675 during the Asian session on Monday. The signs of easing inflation in the United States boost the Fed rate cut hopes, which undermine the US Dollar (USD). Investors will take more cues from the US ISM Manufacturing PMI for June, which is due on Monday.
Data released from the Commerce Department on Friday revealed that the US core PCE, the Federal Reserve’s (Fed) preferred inflation measure, rose 2.6% year over year in May from 2.8% in April, matching the forecast. Meanwhile, the headline PCE climbed 2.6% YoY in May from 2.7% prior, in line with the estimation. The softer US inflation data drags the Greenback lower against the Loonie. San Francisco Federal Reserve Bank President Mary Daly said that it's really challenging to look anywhere and not see monetary policy working: we have growth slowing, spending slowing, the labor market slowing, inflation coming down.”
On the Loonie front, the rise in crude oil prices provides some support to the commodity-linked Canadian Dollar (CAD). It's worth noting that higher oil prices could support the CAD, as Canada is the major crude oil exporter to the United States.
Additionally, inflation remained elevated in Canada in May, raising doubts about the Bank of Canada's (BoC) next interest rate decision. “The Bank of Canada will hold off until September for a second rate cut and then move again in December. Rate cuts are expected to continue throughout 2025 before the overnight rate settles at a neutral level of 2.75% by the end of next year,” according to Deloitte’s Economic Outlook Summer 2024.
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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