How is US Dollar weakness after a Democratic election sweep lifting the Canadian Dollar?

The US Dollar came under pressure as a Democratic sweep in the midterm elections fuelled concerns about political gridlock.
Further losses in the Greenback remain constrained by recent US economic readings that back the Federal Reserve's hawkish position.
Weakening crude oil prices weigh on the Canadian Dollar, restricting the scope for USD/CAD to decline.

Selling pressure keeps USD/CAD on course for a second consecutive daily decline, with the pair trading near 1.3950 in Thursday's Asian session. The move follows heavy selling in the US Dollar (USD) after Democrats swept the midterm elections to take control of both houses of Congress, fuelling fears of possible political gridlock in Washington. Expectations that the election result could bring an end to the Middle East conflict also prompted a sharp fall in oil prices, putting additional pressure on the Greenback.

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

Resilient domestic economic readings could nevertheless cushion the US Dollar's losses by strengthening expectations of a Federal Reserve (Fed) rate hike. The ADP report showed that private-sector employment increased by 86,000 in October, above the 69,000 expected. September's reading, however, was revised down from 90,000 to 86,000. At 54.5, the ISM Services PMI eased from 54.9 and narrowly missed the 54.8 forecast, although it continued to signal a comfortable pace of expansion.

Markets assign a probability of nearly 82% to another interest rate increase in December, according to the CME FedWatch Tool. Attention is shifting to the next US data releases: weekly Initial Jobless Claims on Thursday, followed by Friday's Nonfarm Payrolls (NFP) report.

Falling crude oil prices could, however, limit further declines in USD/CAD by weighing on the commodity-linked Canadian Dollar (CAD). Canada ranks among the largest oil exporters to the United States, leaving its currency directly exposed to lower energy prices.

Crude oil is retreating towards levels close to one-month lows as the Democratic sweep in the US midterm elections raises expectations that the incoming Congress will seek to de-escalate the military conflict with Iran. Acknowledging the Republican election losses, President Donald Trump attributed them largely to voters' frustration with higher gasoline prices linked to the conflict. He also signalled that there were no immediate plans to widen military strikes.

Funding for continuing military operations in the Middle East is expected to face challenges from a Democratic-controlled Congress. Senate Democratic Leader Chuck Schumer has explicitly pledged to push for an end to the war. Meanwhile, a recovery in crude exports from the Persian Gulf has begun, leaving current supply above near-term demand.

Why is the Loonie trailing peers despite recent gains?

Recent appreciation has not been enough for the Canadian Dollar to match other major currencies, according to Scotiabank strategists. Describing the Loonie's performance, they say its “relative performance is somewhat more underwhelming when compared to its peers, and highlights its role as a lower-beta risk and commodity currency,” underscoring its tendency to respond more cautiously than higher-beta FX peers even when market conditions are favourable.

Canadian Dollar: Key Questions Answered

Which factors matter most for the Canadian Dollar?

Interest rates determined by the Bank of Canada (BoC), oil prices, economic conditions, inflation and the trade balance are among the main influences on the Canadian Dollar (CAD). Oil is Canada's largest export, while the trade balance measures the difference between the value of the country's exports and imports. Investor sentiment also matters: demand for riskier assets, known as risk-on, generally supports the CAD, whereas risk-off conditions involve a preference for safe havens. Economic conditions in the US are another important driver, given its position as Canada's largest trading partner.

Why do Bank of Canada policy decisions affect the Canadian Dollar?

By determining the interest rate at which banks lend to each other, the Bank of Canada (BoC) shapes borrowing rates across the economy and exerts considerable influence on the Canadian Dollar. Its primary objective is to keep inflation within 1-3%, raising or lowering interest rates as needed. Comparatively high rates generally support the CAD. The Bank of Canada can also adjust credit conditions through quantitative easing, which tends to weaken the CAD, or quantitative tightening, which tends to strengthen it.

Why is the Canadian Dollar sensitive to oil prices?

As petroleum is Canada's largest export, changes in oil prices typically have an immediate effect on the Canadian Dollar's value. Rising oil prices generally lift the CAD by increasing overall demand for the currency; falling prices tend to have the reverse effect. More expensive oil also increases the likelihood of a positive trade balance, providing another source of support for the CAD.

How can inflation readings affect the Canadian Dollar?

Inflation has traditionally been viewed as harmful to a currency because it erodes the value of money. With cross-border capital controls becoming less restrictive in modern times, however, the effect has in practice been the reverse. Higher inflation often prompts central banks to raise interest rates, drawing in more capital from international investors looking for attractive returns. The resulting increase in demand for the domestic currency supports, in Canada's case, the Canadian Dollar.

Which economic releases can move the Canadian Dollar?

The Canadian Dollar can respond to macroeconomic releases that indicate how well the economy is performing. GDP, Manufacturing and Services PMIs, employment figures and consumer sentiment surveys can all shape the CAD's direction. Economic strength supports the currency by attracting additional foreign investment and potentially encouraging the Bank of Canada to raise interest rates. Weak economic readings, by contrast, are likely to push the CAD lower.