CAD/USD – What Drives This Currency Pair?

CAD/USD is among the top 5 most traded currency pairs in the forex market. It is nicknamed “loonie,” as Canadia’s $1 coin has an image of a common loon (a bird) on the back. The Canadian dollar is also among the “comdolls” or currencies from countries that are highly dependent on exporting commodities. 

While a plethora of factors impact the CAD/USD forex pair, it’s important to watch the most market-moving ones. Here’s a look at these factors. 

Interest Rate Differential

The most important factor impacting the exchange rates of any currency pair in the foreign exchange market is the interest rate differential, or the difference between the interest rates of the two nations. For example, if the interest rate in Canada is 5% and that in the US is 3.5%, their interest rate differential is 1.5 percentage points (5% minus 3.5%). Such a situation makes it more attractive for investors to borrow US dollars, and convert these to Canadian dollars to invest in that country to earn higher returns. This increases the demand for the Canadian dollar. 

CAD/USD traders must keep an eye on changes in interest rates in Canada and the US as this impacts forex trading. The central banks of the respective countries set the benchmark interest rates. While the Bank of Canada, or BoC, determines the prime rate for Canada, the Federal Reserve decides the fed funds rate for the US. 

Remember This Impact: If the Bank of Canada raises interest rates or the Federal Reserve cuts rates, the CAD/USD appreciates. If, on the other hand, the BoC cuts interest rates or the Fed hikes them, the forex pair declines.

What to Watch: CAD/USD traders must watch monetary policy announcements by the BoC and Fed to know if there’s any change in interest rates. Both these central banks hold eight policy meetings every year, during which the benchmark interest rates are announced. 

Inflation

Why do the central bank change interest rates? During periods of high inflation, central banks hike interest rates to encourage people to save instead of spending. This reduces the demand for goods and services and helps to contain inflation.

Remember This Impact: High inflation has an adverse impact on the economy and can exert pressure on a currency. However, if the central bank hikes interest rates to cool inflation, the currency appreciates.

What to Watch: Two main types of inflation data are released by Canada and the US. The Consumer Price Index (CPI) measures the rise in prices at the retail level. The Producer Price Index (PPI) measures prices at the wholesale level. The US also releases the Personal Consumption Expenditure (PCE) price index. This is said to be the Fed’s preferred gauge of inflation. 

Crude Oil

Around 14% of Canada’s exports comprise of crude oil, which is around 4 million barrels per day. Much of these exports are headed to the US. Due to this, the CAD/USD is impacted by changes in oil prices.

Remember This Impact: When crude oil prices rise, the Canadian dollar will appreciate and vice versa. 

What to Watch: Two of the most popular oil benchmarks are Brent and WTI. Brent is a benchmark for oil in the wider market, including the Middle East, Europe, and Africa, while WTI (West Texas Intermediate) is for oil drilled and processed in the US. 

Since Brent and WTI fluctuate continuously in the global financial markets, it’s a good idea to stay on top of the following factors that impact oil prices: 

US Crude Oil Inventories: When oil inventories contract in the US, it indicates a shortage in oil, leading to a rise in oil prices. Similarly, when oil stockpiles increase, oil prices decline.  The American Petroleum Institute (API) reports inventory levels in the US every Tuesday at around 4:30pm Eastern Time. The US Energy Information Administration (EIA) releases its weekly petroleum status report at 10:30 a.m. Eastern Time every Wednesday.

Geopolitical Instability: Global events, like wars, sanctions, and natural disasters, can impact oil prices.

OPEC+ Announcements: The Organization of the Petroleum Exporting Countries (OPEC) and its allies are together known as OPEC+. This organisation, which includes major oil producers like Saudi Arabia and Russia, contribute around 60% of global petroleum exports. Any announcement by the OPEC+ around an increase or decrease in production impacts oil prices.

Economic Growth

When an economy grows, it’s currency appreciates. News of adverse economic developments exert pressure on the currency.

What to Watch: The most important data releases that drive the CAD/USD pair are:

Gross Domestic Product: Data showing higher-than-expected GDP growth in the US or softer-than-anticipated GDP growth in Canada tends to exert pressure on CAD/USD. Similarly, data showing slower-than-expected GDP growth in the US or better-than-anticipated GDP growth in Canada supports the forex pair in the foreign exchange market.

Unemployment: Job additions or declines in the unemployment rate in a country support its currency. This is why the release of the nonfarm payrolls (NFP) report by the US and the jobs report by Canada are closely watched by traders. 

Purchasing Managers’ Index: The PMI signifies the direction of activity in a country’s manufacturing and service sectors. Depending on whether activity is expanding, stagnant, or contracting from the last month, the PMI varies from 0 to 100. A PMI above 50 signifies expansion and below 50 represents contraction, while a reading of 50 indicates no change. 

Traders can ask their forex broker for US and Canada news or simply integrate the economic calendar with their trading platform.

To Sum Up

• CAD/USD is a popularly traded currency pair. 
• The interest rate differential is the most important factor impacting any currency pair.
• Traders of CAD/USD must watch monetary policy announcements by the BoC and Fed, inflation rates, crude oil prices, and economic growth data releases. 

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