The Canadian Dollar (CAD) is facing challenges due to low oil prices and a strong US Dollar. By Tuesday, the USD/CAD exchange rate was around 1.3780 while the US Dollar Index was at 98.57. Recent US manufacturing data showed slower growth, with the Service PMI dropping to 52.5 in December from 54.1 in November. The Composite PMI also fell to 52.7 from 54.2, indicating weaker growth in both the services and manufacturing sectors. New order volumes saw their slowest increase in about twenty months. Concerns about US economic growth are rising, even though lower interest rates are expected to boost demand.

Cautious Fed Outlook

Federal Reserve officials are taking a cautious stance, with some indicating that rate cuts might be needed to support the economy. On the other hand, the Canadian economy is getting limited support from domestic data and oil prices, with West Texas Intermediate trading around $58.00. Focus now shifts to upcoming US Nonfarm Payrolls and Canadian labor data, which are likely to affect policy directions for both the Federal Reserve and the Bank of Canada. Key factors like the US economy, oil prices, and inflation are critical to the CAD’s value, while overall economic performance may lead to higher interest rates and a stronger Canadian Dollar. Last Friday’s job reports supported our view of a slowing North American economy at the end of 2025. The US Nonfarm Payrolls were weaker than expected at 155,000, and Canada reported a net loss of 5,000 jobs. This data gives the Federal Reserve and the Bank of Canada a clear signal to consider cutting interest rates in the first quarter.

Impact of Economic Data on Currency Markets

In the US, this slowdown adds to the cautious tone from Fed officials observed in December. We can see this change reflected in the derivatives market, where Fed funds futures now indicate an over 80% chance of a rate cut by the March 2026 meeting, a jump from about 50% a month ago. This trend suggests that the strength of the US Dollar might start to weaken as monetary policy eases. For the Canadian Dollar, the outlook is more concerning due to a weakening job market and low oil prices. With West Texas Intermediate crude struggling to stay above $58 a barrel, which pressures the Canadian energy sector, the Bank of Canada may need to act quickly. Historically, when job numbers and oil prices fall together, as seen in parts of 2023, the Bank of Canada has quickly indicated a shift toward lower rates. This situation may force the Bank of Canada to cut interest rates sooner and more aggressively than the Federal Reserve. Thus, we recommend strategies that benefit from a rising USD/CAD exchange rate in the coming weeks. The Canadian Dollar is likely to weaken more noticeably compared to the US Dollar. In light of this outlook, we are buying USD/CAD call options with a strike price around 1.3900, set to expire in February and March 2026. This strategy allows us to take advantage of potential gains in the currency pair while managing risk. Increasing uncertainty about central bank actions has also raised implied volatility, making this a strategic time to enter these positions before the market adjusts to a more aggressive Bank of Canada stance. Create your live VT Markets account and start trading now.

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