USD/CAD: U.S. Dollar Weakness Pushes Loonie to Two-Week High; Volatility To Last

The Canadian dollar rose against its U.S. counterpart on Thursday as the U.S. dollar tumbled to a month low after the Federal Reserve reiterated that the interest rate will remain zero for a long time.

Today, the dollar to loonie conversion fell to 1.2447, from 1.2527 on Wednesday. The Canadian dollar had lost about 3% in June – posting the biggest monthly drop since March 2020, the early days of the pandemic, and weakened about 0.6% so far this month.

“Canada’s headline inflation faced a slowdown (from 3.6% to 3.1% YoY) in June. That is probably a welcome development by the Bank of Canada as it supports the central bank’s view that inflation spikes will have a transitory nature. That said, it will hardly impact the BoC’s tapering plans, in our view. After all, the jobs market has proven to be very strong in the recovery and core inflation was broadly unchanged (and above target) from May to June,” noted Petr Krpata, Chief EMEA FX and IR Strategist at ING.

“We remain of the view that the BoC will end asset purchases by the end of 2021 and that the case for the first hike in 2022 is getting stronger. From an FX perspective, we think that the central bank’s hawkishness can help CAD outperform once market sentiment improves and investors find fresh interest in entering reflationary/carry trades.”

The dollar index, a measurement of the dollar’s value relative to six foreign currencies, hit this month’s low of 91.910 and was trading 0.42% lower at 91.934 at the time of writing.

Following the Fed’s monetary policy announcement on Wednesday, the dollar lost momentum after it noted that a rate hike in the near future is unlikely. No hints were given by the U.S. central bank about reducing its purchases of government bonds.

“In terms of the dollar, the currency was slightly softer following the meeting. This suggests currency watchers may have been expecting somewhat stronger guidance from the Fed on the ‘tapering’ issue,” noted analysts at AIB.

“As the European session gets underway this morning, the modestly softer dollar tone is reflected in EUR/USD trading up at the midpoint of $1.18-1.19, while GBP/USD has regained some ground in $1.39 territory. Elsewhere, EUR/GBP remains pinned down near to the 85p mark.”

Nevertheless, the USD is at high risk of recovering over the next year. This is partially due to expectations of two rate hikes in 2023 by the Fed. A stronger dollar and growing odds of the Fed tightening monetary policy sooner than expected would push the USD/CAD pair higher.

Oil prices in Canada have edged higher amid hopes of an inventory report that is expected to be bullish. Higher oil prices result in increased U.S. dollar earnings for Canadian exporters, which translate to a stronger loonie. U.S. West Texas Intermediate (WTI) crude futures traded higher by 0.67 cents, or 0.94%, to $73.06 a barrel.