USD/CAD Recovers Earlier Losses After US PMI Data Beats Expectations

• USD/CAD recovers from early weakness on Thursday following the release of estimate-beating US PMI data in May.
• The services PMI beat estimates, which may be crucial for interest rate expectations given that the Fed has singled out the sector as a hotspot for inflation.
• The Bank of Canada is expected to cut interest rates in June or July, while the Fed won't do so until September at the earliest.

At the time of writing these lines, the pair USD/CAD was trading in the 1.3680 area, after the strong rise registered after the publication of the data Preliminary US Purchasing Managers' Index (PMI) for the services and manufacturing sectors. PMI data showed a higher-than-expected reading in May, indicating an expansion in economic activity which bodes well for the US Dollar (USD) and gives USD/CAD an additional boost.

The US global manufacturing PMI stood at 50.9 in May, above the 50.0 in April and the 50.0 expected by economists. The services PMI, meanwhile, rose to 54.8 from 51.3 the previous month and the expected 51.3. The composite PMI stood at 54.4 points in May, compared to 51.3 in April, and exceeded the decline to 51.1 that economists expected.

The higher-than-expected services PMI data will have provided support to the US dollar as the Federal Reserve (Fed) has highlighted service sector inflation as a key hot spot in the economy that needs to cool before proceeding to cut interest rates. Maintaining higher interest rates supports the USD as it attracts greater foreign capital inflows compared to lower interest rates.

The USD/CAD pair had been trading lower in the day leading up to the data release, due to a mix of rising crude oil prices (CAD positive), positive risk appetite (CAD positive), US data Canadian real estate sector better than expected and resistance of the technical charts. However, following the data, it recovered a substantial part of its previous losses.

The Canadian Dollar (CAD) is likely to see limited upside against the US Dollar (USD), which would provide a lower floor for the pair as interest rate differentials, a key driver of currencies, remain being favorable for the USD. Recent Canadian inflation data for April showed a cooling in price pressures, in line with analyst estimates. The data brought closer the date on which the Bank of Canada (BoC) is likely to cut interest rates. The money markets they estimate the possibility of a 25 basis point (bp) cut in June is 53%, while the possibility of a rate cut in July is completely discounted.

In contrast, the US Federal Reserve (Fed) continues to postpone the expected interest rate cut. More recently, Minutes from the Fed's April-May meeting revealed that policymakers thought interest rates should remain at their current level “at least through September,” and even debated the possibility that rates might need to be raised. A determining factor for the course of future policy would be the evolution of the labor market, they added.