US Dollar weakness after Democratic election sweep lifts Canadian Dollar

Fears of political deadlock after a Democratic midterm election sweep weighed on the US Dollar.
A hawkish Federal Reserve outlook, supported by recent US economic releases, limits the Greenback's losses.
Falling crude prices weigh on the Canadian Dollar, restricting further declines in USD/CAD.

USD/CAD trades near 1.3950. The pair extends its decline into a second consecutive day during Thursday's Asian session. Heavy selling hit the US Dollar (USD) after Democrats secured both houses of Congress in a midterm election sweep, fuelling fears of political deadlock in Washington. The election result also raised market expectations that the Middle East conflict would end. This prompted a sharp fall in oil prices and put additional pressure on the Greenback.

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

Resilient US economic figures have strengthened expectations of a Federal Reserve (Fed) rate hike, potentially limiting the US Dollar's losses. The ADP report showed October private-sector employment rising by 86,000, above the 69,000 forecast. September's increase was revised down from 90,000 to 86,000. The ISM Services PMI eased from 54.9 to 54.5, missing expectations of 54.8 but remaining comfortably in expansion territory.

Markets assign a nearly 82% probability to another December rate hike, according to the CME FedWatch Tool. Attention now shifts to the next US releases: Thursday's weekly Initial Jobless Claims and Friday's Nonfarm Payrolls (NFP) report.

Pressure on the commodity-linked Canadian Dollar (CAD) from weaker crude prices could nevertheless limit USD/CAD's downside. Canada ranks among the largest oil exporters to the United States, leaving its currency directly exposed to falling energy prices.

Crude prices are sliding towards near 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. President Donald Trump attributed Republican election losses largely to voter frustration with higher petrol prices linked to the conflict. He also indicated that there were no immediate plans to widen military strikes.

Military funding for continuing Middle East operations is expected to face opposition from a Democratic-controlled Congress. Senate Democratic Leader Chuck Schumer has explicitly pledged to push for an end to the war. Meanwhile, recovering Persian Gulf crude exports have left current supply above near-term demand.

Lower-beta Canadian Dollar trails peers despite gains

Recent Canadian Dollar gains have not kept pace with those of other major currencies, according to Scotiabank strategists. They describe the Loonie's “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 make more measured moves than higher-beta FX peers, even when market conditions are favourable.

Canadian Dollar: Key Questions Answered

The main drivers of the Canadian Dollar

Interest rates set by the Bank of Canada (BoC), oil prices, economic health, inflation and the trade balance are the principal influences on 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, known as risk-on, supports CAD, whereas risk-off sentiment favours safe havens. The health of the US economy is another major influence, given the United States' position as Canada's largest trading partner.

Bank of Canada decisions and their currency impact

By setting the rate at which banks lend to each other, the Bank of Canada (BoC) influences interest rates across the economy and has a substantial impact on the Canadian Dollar. Its primary objective is to keep inflation at 1-3%, adjusting rates upwards or downwards to achieve that goal. Relatively high rates generally support CAD. The Bank of Canada can also alter credit conditions through quantitative easing or tightening: easing tends to weaken CAD, while tightening tends to strengthen it.

Oil prices and the Canadian Dollar

With petroleum accounting for Canada's largest export, changes in oil prices tend to affect the Canadian Dollar immediately. Rising oil prices generally lift CAD by increasing overall demand for the currency; falling prices usually have the reverse effect. Higher oil prices also make a positive trade balance more likely, providing another source of support for CAD.

Inflation's influence on the Canadian Dollar

Traditionally, inflation was considered harmful to a currency because it erodes the value of money. In modern markets, however, looser cross-border capital controls have reversed that relationship. Higher inflation typically 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's case is the Canadian Dollar.

Economic releases and Canadian Dollar performance

GDP, Manufacturing and Services PMIs, employment figures and consumer sentiment surveys help assess economic health and can shape the Canadian Dollar's direction. A robust economy supports CAD by attracting more foreign investment. It 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.