USD/CAD failed to build on an overnight rebound from 1.3900, described as the week’s low, and edged down in Asia on Thursday. The pair stayed close to Tuesday’s year-to-date high and traded just below the mid-1.3900s, down under 0.10% on the day as signals remained mixed.
Iran said it had closed the Strait of Hormuz after the US launched a fresh wave of strikes, aiding Crude Oil’s recovery from a nearly two-month low hit on Tuesday and lending support to the commodity-linked Canadian dollar. The US Dollar was also restrained, although safe-haven demand remained in focus as tensions risked escalating, while higher energy prices kept inflation concerns elevated and reinforced expectations of a more hawkish Federal Reserve. CME Group’s FedWatch Tool showed markets pricing in over a 70% chance of a rate increase by year-end after CPI rose 4.2% YoY in May, the highest in three years; by contrast, the Bank of Canada was described as dovish. Attention turns to US PPI later in the North American session, alongside Middle East developments and Oil moves.
Strait of Hormuz Escalation Drives Oil and USD/CAD Volatility
We see the recent escalation in the Strait of Hormuz as the primary driver for markets this week. The tensions have sent West Texas Intermediate (WTI) crude prices spiking past $95 a barrel for the first time since 2022, providing significant support for the Canadian dollar. This situation creates a challenging push-and-pull environment for the USD/CAD pair.
However, this geopolitical flare-up simultaneously enhances the US dollar’s safe-haven appeal, putting a floor under the currency pair. Historically, periods of intense Middle East conflict have led to a stronger dollar even with higher oil prices, as global capital seeks safety. We anticipate this dynamic will prevent any sharp sell-off in USD/CAD in the immediate term.
Monetary Policy Divergence and Market Implications
Beyond the headlines, the policy divergence between the US Federal Reserve and the Bank of Canada is widening. With the latest US CPI report for May 2026 showing inflation remains sticky at 3.8%, the Fed is under pressure to maintain its restrictive stance. In contrast, the Bank of Canada is signaling a potential rate cut by year-end as recent GDP figures show the Canadian economy grew by only 0.9% in the first quarter.
Market pricing reflects this growing divide, as the CME FedWatch Tool now shows a 75% probability of the Fed holding rates steady through the summer, killing hopes of a near-term cut. This expectation is keeping US bond yields elevated, a key supportive factor for a higher USD/CAD. We believe options traders should be pricing in higher implied volatility for the coming weeks.
Given these powerful crosscurrents, we feel that outright directional bets on USD/CAD are risky. The potential for a sharp move in either direction is elevated, making long volatility strategies like straddles or strangles attractive. We are looking to profit from a significant price swing, regardless of its direction, as geopolitical news or upcoming inflation data could easily cause a breakout.
