Canadian Dollar recovers as Oil prices rise on Iran hostilities

1.3970 Area: USD/CAD Retreats After Monday’s Rejection Just Below 1.4000.
Renewed fighting in Iran lifts oil prices, giving the CAD another source of support.
With the US midterm election results still awaited, US Dollar gains remain constrained.

1.3970 is the area USD/CAD has fallen to on Tuesday. The Canadian Dollar (CAD) is recovering some ground against the US Dollar (USD), supported by a modest rebound in crude prices after the US resumed hostilities in Iran. Having retreated from session highs just below 1.4000, the pair remains inside Monday’s range and some distance from the seven-week low of 1.3941.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Brent oil gained about 2.8% on Tuesday, moving above $106.00 a barrel after reports that the US military had carried out “defensive” strikes on the Iranian island of Qeshm. The news raised serious doubts over the prospects for the latest efforts to restart peace talks. Tuesday’s crude rebound has supported the Loonie, with oil accounting for Canada’s largest export.

Oil Faces Higher-for-Longer Prices, Analysts Say

TD Securities’ analysts expect a “higher for longer” pricing regime for Brent crude, placing “medium-term fair value for Brent crude oil in the $90-100/bbl region after the eventual conclusion of the conflict in the Middle East.” According to TD Securities, the market will require “one to two years of surpluses to rebuild inventories and buffers to required levels.” That would sustain elevated oil prices and provide a floor for the commodity-sensitive Canadian Dollar.

October’s US factory activity expanded faster than expected, Monday’s US ISM Manufacturing Purchasing Managers' Index (PMI) release showed. The figures underline robust domestic demand, reinforcing the argument for US economic exceptionalism.

Despite those figures, the US Dollar has found little meaningful support. Investors are instead watching Tuesday’s US midterm elections. Opinion polls indicate a Democrat victory in Congress, alongside a tight contest for the US Senate.

Bank of Canada (BoC) Governor Tiff Macklem’s speech is Tuesday’s main event in Canada. Following last week’s interest rate increase and signals of further rises, investors will look for more detail on the timing and scale of the BoC’s tightening cycle.

Canadian Dollar: Key Questions

Canadian Dollar: Main Drivers

Bank of Canada (BoC) interest rates, oil prices, economic health, inflation and the trade balance are among the principal drivers of the Canadian Dollar (CAD). Oil is Canada’s largest export, while the trade balance measures the difference between the value of its exports and imports. Investor sentiment also matters: demand for riskier assets, or risk-on trading, tends to support the CAD, whereas risk-off conditions favour safe havens. The strength of the US economy is another major influence, given that the US is Canada’s largest trading partner.

Bank of Canada Policy and the Canadian Dollar

By setting the interest rate at which banks lend to each other, the Bank of Canada (BoC) shapes borrowing costs across the economy and exerts considerable influence on the Canadian Dollar. Its primary objective is to keep inflation within 1-3%, using interest rate increases or reductions. Higher rates relative to those elsewhere generally support the CAD. Credit conditions can also be influenced through quantitative easing, which is typically negative for the CAD, or quantitative tightening, which is typically positive.

Oil Prices and the Canadian Dollar

As petroleum is Canada’s largest export, changes in oil prices tend to feed directly into the Canadian Dollar’s value. Rising oil prices generally lift aggregate demand for the currency, supporting the CAD; falling prices tend to have the reverse effect. More expensive oil also increases the likelihood of a trade surplus, providing further support for the Canadian Dollar.

Inflation’s Influence on the Canadian Dollar

Traditionally, inflation was regarded as harmful to a currency because it erodes the value of money. In modern times, however, the easing of cross-border capital controls has reversed that relationship. Higher inflation typically prompts central banks to raise interest rates, drawing capital from international investors seeking attractive returns. Those inflows boost demand for the domestic currency, which in Canada is the Canadian Dollar.

Economic Indicators and the Canadian Dollar

Releases of macroeconomic data offer a measure of economic health and can move the Canadian Dollar. GDP, manufacturing and services PMIs, employment figures and consumer sentiment surveys can all affect the CAD’s direction. Economic strength supports the currency by attracting foreign investment and potentially encouraging the Bank of Canada to raise interest rates. Weak data, by contrast, are likely to weigh on the CAD.