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USD/CAD falls to nearly 1.3460 as US dollar weakens ahead of inflation test

  • USD/CAD falls to near 1.3460, with US core PCE inflation and Canadian Q2 GDP data in focus.
  • The Fed is widely expected to begin cutting interest rates in September.
  • Weak Canadian GDP data would prompt the BoC to further ease its monetary policy.

The USD/CAD pair falls to nearly 1.3460 in Thursday's Asian session. The loonie value falls as the US dollar (USD) struggles to maintain Wednesday's recovery move. The US dollar index (DXY), which tracks the greenback's value against six major currencies, declines from 101.18 after a strong recovery from the new yearly low of 100.50.

The US dollar is expected to remain on hold as investors await the US Personal Consumption Expenditure Price Index (PCE) data for July, which will be released on Friday. The PCE report is expected to show that core inflation rose at a faster pace year-on-year, by 2.7%, up from 2.6% in June, with monthly figures growing steadily by 0.2%. The inflation data will significantly influence market speculation about the Federal Reserve's (Fed) monetary policy in September.

Currently, financial market participants seem confident that the Fed will begin cutting interest rates in September. However, traders are still divided on whether the rate cut will be gradual or sharp.

According to the CME FedWatch tool, 30-day federal funds futures price data shows that the probability of a 50 basis point (bp) rate cut in September is 34.5 percent, while the rest prefer a 25 bp cut.

As for the Canadian dollar (CAD), investors are awaiting the monthly and Q2 gross domestic product (GDP) data to be released on Friday. The GDP report is expected to show that the economy barely grew in June, following 0.2% growth in May. On an annual basis, the Canadian economy is expected to have grown at a slower pace, at 1.6%, compared to the earlier release of 1.7%. Signs of a slowdown in the economic outlook would fuel expectations of further interest rate cuts by the Bank of Canada (BoC).

Frequently asked questions about the Canadian dollar

The main factors that affect the Canadian dollar (CAD) are the Bank of Canada (BoC) interest rate level, the price of oil, Canada's largest export commodity, the health of its economy, inflation and the trade balance, which is the difference between the value of Canadian exports and imports. Other factors include market sentiment – whether investors are looking to take on riskier assets (risk-taking) or seek safe havens (risk-averse) – with risk-taking being positive for the CAD. As the largest trading partner, the health of the US economy is also a major factor that affects the Canadian dollar.

The Bank of Canada (BoC) has a significant influence on the Canadian dollar by setting the level of interest rates at which banks can lend money to each other. This affects 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 have a positive effect on the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former negatively affecting the CAD and the latter positively affecting the CAD.

The price of oil is a major factor that affects the value of the Canadian dollar. Petroleum is Canada's largest export commodity, so the price of oil usually has a direct impact on the value of the CAD. When the price of oil rises, the CAD generally rises as well, as overall demand for the currency increases. The opposite is true when the price of oil falls. Higher oil prices also tend to lead to a greater likelihood of a positive trade balance, which also supports the CAD.

While inflation has traditionally always been seen as a negative factor for a currency as it reduces the value of money, in modern times with the loosening of cross-border capital controls, the opposite is actually true. Higher inflation tends to cause central banks to raise interest rates, which leads to more capital inflows from global investors looking for a lucrative investment opportunity for their money. This increases the demand for the local currency, in the case of Canada, that is the Canadian dollar.

The release of macroeconomic data is an indicator of the health of the economy and can impact the Canadian dollar. Indicators such as GDP, manufacturing and services purchasing managers' indices, employment, and consumer sentiment surveys 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, but it can also encourage the Bank of Canada to raise interest rates, leading to a stronger currency. However, if economic data is weak, the CAD is likely to fall.

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