Canadian Dollar remains steady despite falling oil prices

December Fed hike expectations strengthen on firm US CPI; USD/CAD holds steady.
December Fed rate hike expectations have strengthened following elevated US CPI readings.
Falling oil prices, alongside rising US crude inventories, could weigh on the commodity-linked Canadian Dollar.

USD/CAD trades near 1.4250 in Friday’s Asian session. The pair is largely unchanged after two consecutive days of gains. Further upside remains possible, as persistent inflation concerns and expectations of higher interest rates could underpin the US Dollar (USD). Traders await the US October Producer Price Index (PPI) report later on Friday for fresh direction.

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

Expectations of a December Fed rate hike have strengthened after US Consumer Price Index (CPI) inflation figures exceeded forecasts earlier this week. According to Fed Governor Christopher Waller, a 50-basis-point rate hike should be considered if core inflation stays elevated.

A 50-basis-point hike now carries a market-implied probability of 14.5%, compared with zero before Tuesday’s inflation release. Friday’s US PPI figures will be the next focus for signals on inflation and the US central bank’s interest-rate decision. Forecasts put October headline PPI growth at 6.6% YoY and core PPI growth at 5.0% YoY for the same reporting period.

Lower oil prices could provide another source of support for USD/CAD by weighing on the commodity-linked Canadian Dollar (CAD). A build-up in US crude inventories is sapping momentum from West Texas Intermediate (WTI) oil prices.

Oversupply concerns intensified after US crude inventories posted a sharp increase last week. Energy Information Administration (EIA) data showed a 9 million barrels rise in crude stockpiles in the week ending 5 November, following a decline of 5.267 million barrels the previous week. Markets had expected inventories to fall by 1 million barrels.

1.40 support in focus as USD strength pressures Canadian Dollar and Korean Won

TD Securities sees further scope for selective US Dollar outperformance. Its analysts observe that “across global major currencies, we see room for the USD to rally selectively against CAD and KRW in the near-term.” Their view is that “diverging employment data releases will likely keep USDCAD supported above 1.40,” because a “rising unemployment rate amid falling wage growth rate in Canada also reduces the market pricing of a December BoC rate hike relative to the Fed.”

Canadian Dollar: key questions answered

Canadian Dollar: the main drivers

Bank of Canada (BoC) interest rates, oil prices, economic conditions, inflation and the trade balance are 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, known as risk-on sentiment, tends to support the CAD; a preference for safe havens is known as risk-off sentiment. The strength of the US economy is another major influence, given that the US is Canada’s largest trading partner.

Bank of Canada decisions and their effect on CAD

By setting the interest rate at which banks lend to each other, the Bank of Canada (BoC) exerts considerable influence over the Canadian Dollar. That rate feeds through to borrowing costs across the economy. The BoC’s primary objective is to keep inflation within 1-3%, raising or lowering interest rates as needed. Higher rates relative to those elsewhere generally support the CAD. Quantitative easing and quantitative tightening offer additional ways to adjust credit conditions: easing is negative for the CAD, while tightening is positive.

Oil prices and the Canadian Dollar’s response

As petroleum is Canada’s largest export, changes in oil prices tend to affect the Canadian Dollar immediately, making oil a major driver of the currency’s value. Rising oil prices generally lift the CAD by increasing aggregate demand for the currency. Falling prices typically have the reverse effect. More expensive oil also increases the likelihood of a trade surplus, providing further support for the CAD.

Inflation’s role in Canadian Dollar valuations

Traditionally, inflation was regarded as negative for a currency because it erodes the value of money. With cross-border capital controls now more relaxed, however, the relationship has reversed in modern times. Higher inflation tends to prompt central banks to raise interest rates. Those higher rates draw capital from global investors seeking attractive returns, increasing demand for the domestic currency, which in Canada is the Canadian Dollar.

Economic releases and CAD direction

GDP, manufacturing and services PMIs, employment figures and consumer sentiment surveys can all move the Canadian Dollar. These macroeconomic releases indicate the economy’s health. Economic strength supports the CAD by attracting foreign investment and potentially encouraging the Bank of Canada to raise interest rates, which would strengthen the currency. Weak economic figures, by contrast, are likely to weigh on the CAD.