USD/CAD rose for a third day on Thursday, supported by demand for the US Dollar as traders weighed geopolitical developments and fresh US data. The pair was up 0.12%, trading near 1.3723, close to one-month highs.
Higher Oil prices linked to supply disruptions in the Middle East continued to support the Canadian Dollar, which limited further USD/CAD gains. Market focus remained on tensions in the region and their impact on currencies and commodities.
A two-day summit in Beijing between US President Donald Trump and Chinese President Xi Jinping covered trade, bilateral investment and the Iran war. Trump said Xi offered to help on Iran and wants the Strait of Hormuz reopened.
US-Iran peace talks remained deadlocked, with disagreement over Tehran’s nuclear programme. No near-term breakthrough was indicated.
In US data, Retail Sales rose 0.5% month-on-month in April, slower than March’s 1.6% but in line with expectations. The Retail Sales Control Group rose 0.5% after a prior 0.8% increase.
Markets raised the implied chance of a Fed rate hike at the December meeting to about 42% from about 33% a day earlier, based on the CME FedWatch Tool. The US Dollar Index was near 98.78, its highest level in two weeks.
Based on the current situation, we are seeing a classic tug-of-war between a strengthening US Dollar and high oil prices supporting the Canadian Dollar. This tension between a hawkish Fed and Middle East supply risks is likely to create choppy price action in the coming weeks. Traders should be cautious about chasing this rally in USD/CAD without a clear catalyst breaking the stalemate.
The shift in rate expectations is key, as the market is now pricing a 42% chance of a Fed hike by December, a significant change from just a week ago. While April’s US retail sales showed a slowdown from March’s surge, the persistent inflation we saw in recent CPI reports above 3.5% gives the Fed reason to maintain its hawkish stance. This underlying strength in the US economy should keep a floor under the US Dollar.
However, the oil market presents a major headwind for further USD/CAD gains. With West Texas Intermediate (WTI) crude futures holding firm above $85 per barrel due to the ongoing Iran conflict, the Canadian Dollar has a strong pillar of support. Historically, periods of high energy prices have often seen the loonie outperform, even against a broadly strong US Dollar.
Given this uncertainty, we believe options strategies offer a favorable risk-reward profile. Buying USD/CAD call spreads could allow traders to profit from a move towards 1.3800 while defining their maximum loss if oil prices spike and send the pair lower. This is a prudent way to express a bullish view without taking on unlimited risk in a volatile environment.
Looking back to the last major Fed hiking cycle in 2022, we saw that even with elevated oil prices, the US Dollar’s interest rate advantage ultimately drove USD/CAD higher, with the pair breaking above 1.3800. This suggests that if the market becomes fully convinced of a Fed hike, the greenback’s momentum could overpower the support for the loonie from oil. Traders should monitor Fed communications closely for any change in tone.
In the next few weeks, the primary catalysts will be any news from the US-China summit regarding Iran and the release of the May inflation data. A diplomatic breakthrough in the Middle East could remove support for oil and the CAD, sending the pair sharply higher. Conversely, another hot inflation report would likely solidify Fed hike expectations and further boost the US Dollar.
