The Canadian Dollar (CAD) has gained a lot of strength recently. In fact, over the past few trading days, it has been gaining momentum to the upside against both the USD and the GBP. The Bank of Canada’s (BoC) increasingly strict monetary policies and external economic factors, like inflation, played a major role in this shift. The USD/CAD pair was volatile today, falling back under 1.4250, as the CAD continues its strong push higher. In this blog, we take a deeper look into the key drivers affecting the CAD’s performance such as interest rates, oil prices and overall economic activity.
Role of the Bank of Canada
Also the Bank of Canada — an independent central bank — plays a major role in determining the value of the Canadian Dollar. It does this primarily through manipulating interest rates. FOMC’s target rates determine how much it costs for banks to borrow from one another and, in turn, help shape the economy’s overall financial conditions. Investors are abuzz with speculation. They think the Bank of Canada will move to a neutral monetary policy posture following an extended dovish posture beginning in June 2024. If implemented, such a shift might strengthen the CAD even more.
The BoC’s main tool, as they admit, is to use quantitative easing or quantitative tightening to impact credit conditions. So, all else equal, quantitative easing is CAD-negative and tightening is CAD-positive. The central bank’s main objective is to keep inflation between 1-3%. Raising or lowering interest rates is the most important tool that regulators use to maximize this dual mandate.
This month’s inflation data is especially important as it will serve to further cement or dispel market expectations for the Federal Reserve’s monetary policy outlook. This, in turn, has important implications for the value of the USD/CAD exchange rate. With inflation being a key factor, any significant changes could alter the course of monetary policy decisions by both the BoC and the Fed.
Impact of Oil Prices and Economic Health
Oil prices are another key driver that affects how much Canadian Dollar is worth. Since petroleum is Canada’s largest export, increases or decreases in the price of oil are felt quickly by the CAD. When oil prices increase, a common effect is an immediate appreciation of the CAD as Canada receives more revenue from its oil exports. In contrast, when oil prices decline, the CAD usually depreciates.
Perhaps the most impactful element poisoning the CAD is the current health of the US economy. A robust US economy means more demand for Canadian exports, which in turn strengthens the CAD. If the US economy gets into trouble, it can pull down Canada’s exports and put downward pressure on its currency.
Canada’s economic health is directly connected to its currency value. Strong economic fundamentals are a positive prospect for the CAD, as they point to stability and the possibility of growth. For investors, economic indicators are paramount, and for many of the same reasons, for policymakers too. They focus heavily on promoting GDP growth, employment rates and trade balances.
Current Market Trends
On the daily chart, the USD/CAD pair is barely holding above the 100-period Exponential Moving Average (EMA), at 1.4226. That would indicate generally bullish sentiment overall, even with the pair dipping in value recently. The Canadian Dollar is getting a boost. Investors are hopeful that the Bank of Canada will move its monetary policy tilt to a more neutral one.
See, for example, how the recent Canadian Dollar recently became the strongest currency on the British Pound. This move further cements CAD’s increasing strength in the global currency market. It’s critical to understand changeable exchange rates always can be affected positively or negatively by various key or otherwise powerful influencing factors.
These opinions are the authors’ own as expressed in this piece. These views are not FXStreet’s, or anyone else as far as FXStreet is concerned. The author and FXStreet are not registered investment advisors, and nothing contained herein is intended to be investment advice. All market participants need to do their own due diligence before investing in these products.