USD/CAD is down as firm Fed rate cut prospects weigh on the US dollar

The key factors driving the Canadian dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of oil, Canada’s largest export, the health of its economy, inflation and the trade balance, which is the difference between the value of Canada’s exports and imports this one. Other factors include market sentiment – ​​whether investors are taking riskier assets (risk-on) or seeking safe havens (risk-off) – with risk-on being positive for CAD. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian dollar.

The Bank of Canada (BoC) has significant influence on the Canadian dollar by setting the level of interest rates at which banks can lend to each other. This influences the level of interest rates for everyone. The BoC’s main goal is to keep inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence lending conditions, the former being negative CAD and the latter positive CAD.

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 tends to have an immediate impact on the value of the CAD. In general, if the price of oil rises and the CAD rises, as the aggregate demand for the currency rises. The opposite is true if the price of oil falls. Higher oil prices also tend to result in a higher probability of a positive trade balance, which also supports the CAD.

While inflation has always traditionally been considered a negative factor for a currency because it decreases the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to prompt central banks to raise interest rates, which draws more capital inflows from global investors looking for a profitable place to keep their money. This increases the demand for the local currency, which in Canada’s case is the Canadian dollar.

Macroeconomic data highlights the health of the economy and can impact the Canadian dollar. Indicators such as GDP, manufacturing and services PMIs, employment surveys and consumer sentiment can all influence the direction of the CAD. A strong economy is good for the Canadian dollar. Not only does it attract more foreign investment, it can encourage the Bank of Canada to raise interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.