US Dollar strength and lower oil prices push Canadian Dollar lower

Caution across markets lifts USD/CAD before the Fed and BoC announce their interest rate decisions.
An October Fed pause carries an 89.5% market-implied probability, with any further rate hikes potentially deferred until December.
Middle East diplomacy drives crude prices lower, adding pressure on the commodity-linked Canadian Dollar.

USD/CAD trades near 1.4020 in Tuesday’s Asian session. The pair is advancing for a second consecutive day as caution ahead of Wednesday’s interest rate decisions from the US Federal Reserve (Fed) and the Bank of Canada (BoC) supports further US Dollar (USD) gains.

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

An 89.5% probability of unchanged rates at the October policy meeting is reflected in current pricing, according to the CME FedWatch Tool. Markets also assign an 82.3% probability to a December rate increase. Financial markets therefore anticipate that the Federal Reserve will hold rates steady at its forthcoming October meeting before a possible further hike in December.

At Navy Federal Credit Union, chief economist Heather Long described the inflation backdrop: “Inflation is still the No. 1 problem in the US economy, and there are a lot of signs it is getting more broad-based.” She also said, “For consumers, it means really high borrowing costs for the foreseeable future.” On the timing of a policy move, Heather added that “given that it’s right before an election,” “they won’t hike in October.”

Lower oil prices are weighing on the commodity-linked Canadian Dollar (CAD), providing further support for USD/CAD. Renewed diplomacy in the Middle East has fuelled hopes that a broader escalation of the US-Iran conflict can be avoided, pushing crude prices down.

Iran, Saudi Arabia, Pakistan, and Turkey agreed on Monday to keep security talks going and strengthen regional cooperation after high-level discussions in Tehran, according to Islamic Republic of Iran Broadcasting (IRIB). The first meeting between Iran and senior representatives of the Mecca Joint Defence Agreement produced a joint statement. It said the four countries had agreed to sustain dialogue and consultations, particularly on regional peace, security, and stability.

Canada’s stance in trade negotiations with the United States (US) remains unchanged, Canadian Prime Minister Mark Carney said on Monday. Any progress, Carney added, reflects Washington moving closer to Canada’s position.

Four Hikes Priced In by 2027 as BoC Rate-Hike Risk Builds

Recent remarks from Governor Tiff Macklem have substantially altered the policy outlook, according to Commerzbank analysts. They note that “Macklem’s latest comments have significantly increased the risk of an imminent rate hike, and we therefore expect an initial move before the end of this year.” On the immediate decision, the analysts say “market participants assign an 85% probability to a rate hike this week, and we also expect a hike given the recent more hawkish comments,” while adding a qualification: “we nevertheless consider such a move due to the subdued core inflation premature.” For the longer-term outlook, Commerzbank notes that “a total of four rate hikes are priced in by September 2027,” highlighting the scale of the market’s hawkish repricing of the BoC policy path.

Canadian Dollar: Key Questions Answered

Which factors shape Canadian Dollar movements?

Interest rates set by the Bank of Canada (BoC), oil prices, economic conditions, inflation and the trade balance are the main drivers of the Canadian Dollar (CAD). Oil is Canada’s largest export, while the trade balance measures the difference between the value of exports and imports. Investor appetite for risk also matters: a risk-on environment, in which investors favour riskier assets rather than safe havens, generally supports CAD. Conversely, risk-off sentiment reflects a preference for safe havens. The condition of the US economy is another important influence, as the US is Canada’s largest trading partner.

Why do Bank of Canada decisions matter for the Canadian Dollar?

By determining the interest rate at which banks lend to each other, the Bank of Canada (BoC) influences borrowing rates throughout the economy and, in turn, the Canadian Dollar. Its primary objective is to keep inflation at 1-3%, raising or lowering interest rates to achieve that goal. Higher relative interest rates generally support CAD. The BoC can also alter credit conditions through quantitative easing or quantitative tightening. Easing tends to weigh on CAD, whereas tightening tends to support it.

Why is the Canadian Dollar sensitive to oil prices?

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 CAD, strengthening the currency; falling prices tend to have the reverse effect. More expensive oil also increases the likelihood of a trade surplus, offering additional support to CAD.

What links inflation figures to the Canadian Dollar?

Inflation was traditionally viewed as a drag on currencies because it erodes the value of money. With cross-border capital controls relaxed in modern times, however, the relationship has generally reversed. Higher inflation often prompts central banks to raise interest rates, drawing capital from international investors seeking attractive returns. Those inflows increase demand for the domestic currency, which in Canada is the Canadian Dollar.

Which economic releases can move the Canadian Dollar?

GDP, manufacturing and services PMIs, employment figures and consumer sentiment surveys can all steer CAD by signalling the economy’s condition. A healthy economy supports the Canadian Dollar through stronger foreign investment and may also prompt the Bank of Canada to raise interest rates, strengthening the currency further. Weak economic readings, by contrast, are likely to weigh on CAD.