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USD/CAD remains below 1.3650 on dovish Fed sentiment

  • USD/CAD loses ground as the US Dollar faces challenges following weaker-than-expected US jobs data released on Friday.
  • According to CME’s FedWatch tool, the probability of a Fed rate cut in September has risen to 70.7%, from 64.1% just a week ago.
  • Canada’s 10-year government bond yield fell below 3.53%, signaling an accommodative stance by the BoC.

The USD/CAD is retracing its recent gains, trading around 1.3630 during the Asian session on Monday. This drop is attributed to the weakness of the US Dollar (USD) following the weaker than expected US job growth data released on Friday. This has increased the likelihood of the Federal Reserve (Fed) cutting interest rates sooner rather than later.

US Nonfarm Payrolls (NFP) rose by 206,000 in June, following an increase of 218,000 in May. This figure was above the market expectation of 190,000. The US unemployment rate rose to 4.1% in June from 4.0% in May. Meanwhile, average hourly earnings declined to 3.9% year-over-year in June from the previous reading of 4.1%, in line with market expectations.

According to CME’s FedWatch tool, rate markets are currently pricing in a 70.7% chance of a rate cut in September, up from 64.1% just a week ago. The dollar faced challenges as Fed Chair Jerome Powell said last week that the central bank is returning to a disinflationary path, according to Reuters.

However, minutes from the Federal Reserve’s June policy meeting indicated that Fed officials were taking a cautious “wait-and-see” approach. Some participants highlighted the Committee’s commitment to a data-dependent approach.

In Canada, the unemployment rate rose to 6.4% in June, exceeding the expected 6.3% and reaching its highest level since January 2022. This increase highlights the Bank of Canada’s (BoC) concerns that high interest rates are putting significant pressure on the labour market, prompting calls for possible rate cuts to support the economic recovery. In addition, Canada’s 10-year government bond yield fell below 3.53%, reflecting expectations of a more accommodative stance by the central bank.

The commodity-linked Canadian Dollar (CAD) could see limited gains due to falling crude oil prices. Canada, a major exporter of crude oil to the United States (US), is seeing West Texas Intermediate (WTI) oil trading around $82.40 per barrel at the time of writing. Geopolitical tensions in the Middle East eased with prospects of a ceasefire in Gaza, contributing to the fall in oil prices.

Canadian Dollar FAQs

The key factors determining the Canadian dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of oil, Canada’s main export, the health of its economy, inflation and the trade balance, which is the difference between the value of Canadian exports and its imports. Other factors include market sentiment, i.e. whether investors are betting on riskier assets (risk-on) or looking for safe assets (risk-off), with risk-on being positive for the CAD. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian dollar.

The Bank of Canada (BoC) exerts significant influence over the Canadian dollar by setting the level of interest rates that banks can lend to each other. This influences the level of interest rates for everyone. The BoC’s main objective is to keep inflation between 1% and 3% by adjusting interest rates up or down. Relatively high interest rates are generally positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former being negative for the CAD and the latter being positive for the CAD.

The price of oil is a key factor influencing the value of the Canadian dollar. Oil is Canada’s largest export, so the price of oil tends to have an immediate impact on the value of the CAD. Generally, if the price of oil rises, the CAD rises as well, as aggregate demand for the currency increases. The opposite occurs if the price of oil falls. Higher oil prices also tend to lead to a higher probability of a positive trade balance, which also supports the CAD.

Although inflation has traditionally always been considered a negative factor for a currency, as it reduces the value of money, the opposite has actually occurred in modern times, with the relaxation of cross-border capital controls. Higher inflation typically leads central banks to raise interest rates, which attracts more capital inflows from global investors looking for a lucrative place to store their money. This increases demand for the local currency, which in Canada’s case is the Canadian dollar.

The released macroeconomic data measures the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, manufacturing and services PMIs, employment and consumer confidence surveys can influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment, but it can encourage the Bank of Canada to raise interest rates, which translates into a stronger currency. However, if the economic data is weak, the CAD is likely to fall.

Source: Fx Street

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