The US Dollar is on the rise for the second day in a row, thanks to strong US economic data, including solid business activity and lower Jobless Claims. This positive news supports the Federal Reserve’s decision to keep interest rates steady, which in turn boosts US Yields and the Dollar. The USD/CAD exchange rate is currently at 1.3670, after hitting a high of 1.3780 earlier today, even though it has dropped by 0.3% over the week. The overall trend looks bearish, but the recent higher lows indicate that the pair may be stabilizing.

Confidence in the Federal Reserve

There is growing confidence in a more aggressive Federal Reserve, which is helping the USD. Recent data shows improvements in the US services sector, which overshadows a decline in manufacturing. This confirms a strong labor market with fewer Jobless Claims. Meanwhile, the Canadian Dollar is struggling, following a 1.1% drop in May retail sales. This aligns with market expectations but raises the chances of a rate cut by the Bank of Canada, negatively affecting views on potential rate changes at their upcoming meeting. The Federal Reserve plays a key role in the strength of the US Dollar by adjusting interest rates to maintain price stability and employment. Generally, Quantitative Easing weakens the Dollar, while Quantitative Tightening strengthens it. Given the differences in economic policy, we believe it makes sense to position for further strength in the USD against the CAD. The strong US data supports a more aggressive monetary policy, contrasting with the situation in Canada.

Indicators of Canadian Economic Health

Recent statistics bolster our perspective. The S&P Global Flash US Composite PMI for June jumped to 54.6, reaching a 26-month high. Additionally, jobless claims remain low at 238,000, highlighting the resilience of the American economy and reducing the likelihood of interest rate cuts soon. In contrast, Canada’s economic situation is weakening. The annual inflation rate dropped to 2.7% in May, and the central bank has already begun cutting rates, with a 25-basis-point reduction on June 5th. We foresee a high chance of another cut at the July 24th meeting, which will likely put more pressure on the CAD. For derivatives traders, this scenario suggests buying call options on the USD/CAD pair. This strategy allows you to benefit from expected price increases while limiting potential losses to the premium paid. It’s a straightforward and secure way to capitalize on the differing economic forecasts. Historically, major policy differences between countries have led to sustained movements in currency pairs. For example, between 2014 and 2016, when the US was tightening and Canada was easing, the pair surged over 30%. While we don’t anticipate a rise of that scale this time, it highlights the potential for significant movements. Expect increased volatility around upcoming economic data and central bank announcements. Therefore, we also see value in using option spreads, such as a bull call spread, to lower the initial trade cost. This allows for potential profits from a moderate rise in the pair while creating a more budget-friendly structure. Create your live VT Markets account and start trading now.

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