USD/CAD rose to almost 1.3580 during early trading in Asia on Tuesday. The US Dollar strengthened due to rising tensions in the Middle East, particularly between Israel and Iran, which could escalate into a larger regional conflict. Market attention is on the US May Retail Sales data, expected later today, which may affect the USD/CAD exchange rate. The Canadian Dollar could gain from increasing crude oil prices, as Canada is a major oil exporter to the US. Recent US inflation data suggests that the Federal Reserve might cut interest rates. Traders estimate there is about an 80% chance of a rate cut in September, followed by another in October.

Factors Affecting the Canadian Dollar

Several key factors influence the Canadian Dollar, including the Bank of Canada’s interest rate decisions, oil prices, economic performance, inflation, and trade balance. Data on GDP and employment are also important since a strong economy attracts investments and may lead to higher interest rates. Higher oil prices benefit the Canadian Dollar because oil is Canada’s largest export. Additionally, inflation impacts the currency; rising inflation could lead to higher interest rates, attracting more capital. The recent rise above 1.3580 in USD/CAD is mainly due to external factors, particularly turmoil in the Middle East. The conflict between Israel and Iran has increased global demand for safe-haven currencies, boosting the US Dollar. Early trading this week is heavily influenced by geopolitical risk. The US Retail Sales data for May could provide insight into consumer spending, which is crucial for monetary policy. If the data exceeds expectations, we might see reduced support for policies aimed at easing, especially around the anticipated rate cuts in September and October. However, with recent inflation trends suggesting moderation, many in the rates market believe the Federal Reserve is likely to ease rates in the latter half of the year. This belief is already reflected in the futures market, which assigns an over 80% probability to rate cuts this autumn. In Canada, the Loonie often rises and falls with oil prices due to the country’s resource-based economy. Recent gains in the energy market, including Brent and WTI oil benchmarks, have supported the Canadian Dollar against other G10 currencies. Additionally, domestic economic data, such as inflation and employment figures, is under scrutiny. Stronger GDP or tighter job data could push for interest rate increases or postpone cuts.

Potential Market Impact

The Bank of Canada has shown readiness to diverge from the Federal Reserve, putting it in a challenging position. If oil prices remain high and inflation doesn’t decrease as expected, Governor Macklem and his team may refrain from further interest rate cuts. With inflation previously exceeding acceptable levels, the Bank must be careful with its guidance. Meanwhile, strong retail figures from the US and hawkish statements from the FOMC could keep USD/CAD on a high trajectory. In terms of trading strategies, monitoring energy markets is as important as observing macroeconomic trends. Unexpected decreases in US inventories or new OPEC comments may influence Canadian growth outlook, affecting interest rate expectations in Canada. With increased market volatility, traditional correlations may not hold, so it’s essential to be alert for potential divergences. Overall, the current trend tends to favor the USD during risk-off periods due to its status as a reserve currency and its liquidity. However, there are times when oil-related trades boost the Canadian Dollar, though these gains can quickly reverse if market sentiment changes. It’s crucial to track interest rate differentials and significant news events closely, rather than relying solely on broader trends. Relative yields, particularly the 2Y spread, may predict future movements. Traders should adjust their short-term models to be more sensitive to these changes. Attention should also be paid to central bank officials’ speeches; a stronger dovish tone could shift expectations faster than anticipated. As summer progresses, lower liquidity during regional holidays or between major economic reports could amplify moves in this trading pair. A spike in futures-implied volatility could reveal insights into near-term hedging strategies that might not be obvious from price movements alone. Staying adaptable and responsive to data is crucial, especially with geopolitical events and price-sensitive algorithms increasingly shaping short-term trading strategies. Create your live VT Markets account and start trading now.

here to set up a live account on VT Markets now