The Canadian Dollar experienced a notable surge on Wednesday, rallying four-tenths of one percent to reach a new five-week high against the US Dollar. This rise proved to be a short term high for the Loonie, undoubtedly showcasing a favorable sentiment towards the currency from investors. Yet the Canadian Dollar rally proved to be short-lived as it quickly gave back those gains and came back down towards flat on the day. The fluctuations in the Loonie's value underline the complexities influencing its performance, including interest rates, oil prices, economic health, and trade balances.
Canadian Dollar's Volatile Journey
On Wednesday, the Canadian Dollar scored notable gains against its US counterpart. The Loonie advanced to a new five-week high, highlighting its underlying room to climb in the FX marketplace. After this auspicious beginning, the Canadian Dollar faced challenges that caused it to turn back. During the day, the currency was on a roller coaster ride. By the market’s close, it had returned almost to the point where it started.
The other main driver of the Canadian Dollar’s movement is crude oil prices. Key among these are the interest rates set by the Bank of Canada, which play a crucial role in shaping investor sentiment. Furthermore, the oil price – of which oil is Canada’s most important export by far – has a strong direct correlation with the value of the Loonie. Due to the loonie being a commodity-driven currency, increases or decreases in the price of oil require the Canadian Dollar to follow suit.
Economic Health and Trade Balance
Beyond interest rates and oil prices, the overall health of Canada's economy is instrumental in determining the Canadian Dollar's strength. Inflation rates are a key factor in this complicated equation, directly impacting purchasing power and consumer and investor confidence. The Trade Balance, representing the difference between Canada's exports and imports, further influences the currency's valuation. A good trade balance usually supports the Canadian Dollar, while a bad one complicates the situation.
The Bank of Canada still has some quantitative easing and tightening tools to respond to positive or negative economic conditions. Sure enough, quantitative easing, which increases money supply and lowers interest rates, is typically CAD-negative. On the other hand, quantitative tightening tends to be CAD-positive because it is designed to tighten money supply. The success of these measures is extremely reliant on favorable economic data. If the data is very weak then we may see a sharp pullback in the Canadian Dollar.
Impact of Global Developments
The loonie does not move in a vacuum though, and it is influenced by what happens elsewhere in the global economy. Market activity skyrocketed on Wednesday when it became known that former US President Donald Trump was set to announce an auto tariff. This move drove an impressive reversal in the US Dollar. As Canada's largest trading partner, the health of the US economy has a direct bearing on the Loonie's fortunes. Notably, healthy economic times south of the border improve prospects for Canadian exports. Together, they’ll amplify the impact of this new surge in demand, strengthening the value of the Loonie.
This constant tussle between domestic and international factors makes for a complicated backdrop for the Loonie. Investors pay close attention to economic indicators released by Canada, and by Canada’s trading partners, in an effort to predict when a currency’s value may change direction. Although Wednesday’s rally demonstrated the Loonie at its best, the rally nonetheless illustrated the currency’s volatility and susceptibility to external shocks.