USD/CAD fell on Friday, trading near 1.3670, down 0.26% on the day. The pair stayed under pressure as the Canadian Dollar strengthened even though oil prices dropped.
Markets reacted to Middle East developments after Iran’s Foreign Minister Abbas Araghchi said the Strait of Hormuz is fully open to commercial shipping during the ceasefire. This followed weeks of tension around the route.
The reopening pushed oil lower as supply disruption fears eased. West Texas Intermediate traded near $80 per barrel and recorded one of its steepest daily falls in recent weeks, with Gulf export flows expected to return to normal.
The Canadian Dollar rose despite its usual link to energy prices, suggesting US Dollar weakness was the main driver. The US Dollar Index traded near multi-week lows around 97.80 as markets reviewed the US interest-rate outlook.
CME FedWatch showed a 38.2% chance of a 25-basis-point Federal Reserve rate cut by year-end, up from 25.9% the prior day. In Canada, March CPI is due on Monday and is expected to accelerate due to the energy shock linked to the Iran war.
Bank of Canada Governor Tiff Macklem said the economy could face “higher price levels”. He also referred to the task of keeping inflation anchored without causing a sharp slowdown.
The Canadian dollar is strengthening against the US dollar even though oil prices are falling sharply, and we need to react to this unusual divergence. This break from the normal correlation, where a weaker oil price typically hurts the loonie, presents a key opportunity. The market is currently more focused on what central banks will do next rather than on energy prices.
We are seeing broad weakness in the US dollar as the drop to $80 a barrel for oil reduces fears of American inflation. This has led markets to increase the odds of a Federal Reserve rate cut later this year, a view supported by the recent March jobs report which showed a modest cooling in the labor market. This narrative of a softening US economy is the primary force pushing the USD/CAD pair lower for now.
The main event for us in the coming days is Monday’s release of Canadian inflation data. If the Consumer Price Index comes in as hot as anticipated, it will reinforce the view that the Bank of Canada must remain vigilant, keeping its policy tight while the Fed considers easing. This growing policy difference is what traders are currently betting on, favoring the Canadian dollar.
However, we must consider that the current disconnect between oil and the Canadian dollar may not last. Looking back at data through 2024, the positive correlation between crude prices and the loonie was extremely reliable, and a sustained period of lower energy prices will eventually weigh on Canada’s economy. This makes betting on continued Canadian dollar strength a potentially risky trade if market focus shifts back to commodities.
Given these strong but opposing forces, positioning for a large move in either direction seems like a prudent strategy. One-month implied volatility on USD/CAD options has risen to a three-month high of 8.5%, indicating the market is already pricing in a significant price swing following the inflation report. Using options to trade this expected volatility, rather than picking a firm direction, could be the most effective approach in the coming weeks.
