During the Asian trading hours on Tuesday, the USD/CAD pair is trading with slight gains near 1.3720. However, the benefits for this pair may be confined as Federal Reserve (Fed) uncertainty and concerns about another US government shutdown could put selling pressure on the US dollar (USD) against the Canadian dollar (CAD). Major Fed and Bank of Canada (BoC) interest rate decisions will be the most vital events later Wednesday.
The BoC is widely expected to leave its key interest rate unchanged at 2.25% at its January meeting on Wednesday as inflation remains within its target range. The U.S. central bank is also expected to split its stance on Wednesday, even as it grapples with a variety of issues, including U.S. President Donald Trump’s attempts to undermine the central bank’s independence and questions about who will replace Jerome Powell as chairman when his term ends in May.
Last week, Trump said he would soon announce the next Fed chairman to replace Chairman Jerome. Speculations about the next Fed chairman may weigh on the dollar as markets expect a candidate who will advocate faster interest rate cuts.
The U.S. government is moving toward a partial shutdown after top U.S. Senate Democrat Chuck Schumer vows to oppose a funding package that includes funds for the Department of Homeland Security. Congress has been given a January 30 deadline to fund the government, otherwise there is a risk of a partial government shutdown, which could cause the USD to fall against the CAD.
On the other hand, Trump’s renewed tariff threats could limit Loonie’s advantage. On Saturday, Trump threatened to impose 100% tariffs on Canadian goods if the country strikes a trade deal with China, raising fears of a renewed trade war.
Canadian Dollar FAQs
The key factors shaping the Canadian dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of crude oil, which is Canada’s largest export, the condition of its economy, inflation and the trade balance, i.e. the difference between the value of Canadian exports and imports. Other factors include market sentiment – whether investors are taking on riskier assets (with risk) or looking for protected havens (with risk), with risk being positive relative to CAD. As the United States’ largest trading partner, the health of the U.S. economy is also a key factor influencing the exchange rate of the Canadian dollar.
The Bank of Canada (BoC) has significant influence over the Canadian dollar by setting the interest rates that banks can lend to each other. This affects the level of interest rates for everyone. The main goal of the BoC is to keep inflation at 1-3% by raising or lowering interest rates. Relatively higher interest rates tend to benefit CAD. The Bank of Canada may also utilize quantitative easing and tightening to influence lending terms, with the former being CAD negative and the latter CAD positive.
The price of oil is a key factor influencing the value of the Canadian dollar. Oil is Canada’s largest export, so the price of oil usually has a direct impact on the value of CAD. Generally speaking, if the price of oil increases, CAD also increases because aggregate demand for the currency increases. The opposite is true when the price of oil falls. Higher oil prices also tend to result in a greater likelihood of a positive trade balance, which also supports CAD.
While inflation has always traditionally been considered a negative factor for currency because it reduces the value of money, in current times the opposite has been true with the relaxation of cross-border capital controls. Higher inflation prompts central banks to raise interest rates, which attracts more capital inflows from global investors looking for a lucrative place to keep their money. This increases demand for the local currency, which in Canada’s case is the Canadian dollar.
Macroeconomic data releases are used to assess the condition of the economy and may affect the Canadian dollar. Indicators such as GDP, manufacturing and services PMIs, employment and consumer sentiment surveys can influence the direction of CAD. A mighty economy is good for the Canadian dollar. Not only will it attract more foreign investment, but it could encourage the Bank of Canada to raise interest rates, leading to a stronger currency. However, if economic data is delicate, CAD will likely decline.
