The Canadian Dollar (CAD) is a uniquely sensitive and responsive float to the changing landscape of global economic pressures. A whole host of influences arguably makes its value in constant flux. Few factors are as visible to Canadians as the interest rates established by the Bank of Canada (BoC). The price of oil remains extremely volatile. The CAD, a commodity currency, is notably impacted by Canada's largest export, oil, which sees its prices swayed by global supply concerns and geopolitical tensions. As the United States remains Canada's largest trading partner, the health of the US economy plays a crucial role in determining CAD's trajectory.
Bank of Canada and Interest Rates
The Bank of Canada’s central banks’ role in deciding how much any currency, including the Canadian Dollar, is worth can not be stressed. The interest rates for bank lending are set by the BoC. By taking this action, it has given itself substantial leverage over the CAD. Under the new bank act, the bank is required to manage inflation within a target range of 1-3%. Just to cool down an overheated economy, we raise interest rates. To promote the job-creating growth we need, we raise them.
We know that interest rate decisions are not made in a vacuum, but by consideration of many key economic indicators. These are things like GDP, Manufacturing and Services PMIs, total employment numbers, consumer sentiment surveys and more. A healthy economy is often reflected in a strong CAD. This renewed economic strength means we should expect higher highs in interest rates at some point. Conversely, weaker economic data might prompt the BoC to lower rates, which could lead to a depreciation of the CAD.
Beyond interest rate hikes, the BoC has the option to use quantitative easing or quantitative tightening to get a more direct hold on credit conditions. Quantitative easing, usually viewed as a CAD-negative, is a monetary policy tool consisting of pumping liquidity into the economy to revive growth. QT is CAD-positive. At the same time, this process drains liquidity, which will put upward pressure on interest rates.
Oil Prices and Their Impact
Oil prices represent the most important fundamental driver of the Looney. As one of Canada's largest exports, oil directly impacts the country's trade balance. And higher oil prices, everything else equal, usually contribute to a more favorable trade balance, thus supporting the CAD. This relationship is further magnified by Canada’s role as an increasingly important global energy supplier.
Recent geopolitical shocks in the Middle East, including the Israel-Hamas war, have played a role pushing oil prices higher. Disruption worries amid Russian invasion of Ukraine and a bigger than expected fall in US crude stockpiles have added to these rises. When oil prices rise, so does the need for the CAD, indicating a bullish outlook on Canadian oil trade and thus the CAD appreciated.
The oil price-CAD relationship is not necessarily cut and dry. Rising oil prices increase the CAD through enhanced trade balances and addressing markets on the strong performance of exports. They can be a catalyst for inflationary pressures. Importantly, policymakers should pay close attention to the dual effect. They must ensure that inflation does not exceed targets while continuing to stimulate economic development.
US Economic Health and Trade Relations
The health of the US economy is another important driver of the Canadian Dollar. After all, as Canada’s largest trading partner, any ups and downs in US economic performance are felt in the Great White North. A robust US economy usually means more demand for Canadian exports, which would further bolster the CAD.
Any signs of weakness in the US economy can have negative effects on demand for Canadian goods and services. This decrease in demand leads to the CAD being put under bearish pressure. Many observers are watching the state of trade relations between the two countries. So any disruptions or tariffs will have a dramatic effect to the downside on the Canadian dollar.
Furthermore, factors like US employment numbers, GDP growth, and consumer confidence all work into this equation. What’s more, good news from these regions helps create a positive climate for trade throughout the Canada-US relationship. This, in turn, creates a backdrop for a much stronger CAD.