USD/CAD: Loonie Hits Seven-Week Low on Firm Greenback, Weak Crude Oil Prices

The Canadian dollar hit its lowest level in nearly seven weeks against the U.S. counterpart in early trading on Friday as crude oil prices fell below $80 and the greenback hovered close to the 16-month high on increasing bets that the Fed would raise interest rates sooner than previously thought.

“The Bank of Canada shifted to a more hawkish stance in October by ending QE and signalling the first hike should come in 2Q22 or 3Q22. Markets are currently pricing in the first hike at the March meeting and see a total of 125bp of tightening in 2022,” noted Francesco Pesole, FX Strategist at ING.

“We currently forecast four 25-bp rate hikes in 2022, so expect only limited scope for a re-pricing of tightening expectations. Having the lowest volatility among G10 commodity currencies, CAD may emerge as a popular carry bet against low-yielders next year. We think CAD has the lowest downside risk in the commodity FX space and expect USD/CAD to stay closer to 1.20 rather than to 1.25 in 2022.”

Today, the USD/CAD pair rose to 1.2661 up from Thursday’s close of 1.26. After gaining about 2.3% last month, the Canadian dollar weakened over 2.1% so far this month.

The dollar index, which measures the value of the dollar against six foreign currencies, was trading 0.51% higher at 96.030 – not far from the 16-month high of 96.266 hit on Wednesday. The greenback rose to 16-month highs against most other major currencies because of the hottest U.S. inflation reading in a generation that pushed investors to bet that interest rates are likely to rise sooner than previously thought.

It is highly likely that the world’s dominant reserve currency, the USD, will rise by end of the year, largely due to the expectation of at least one rate hike next year. With the dollar strengthening and a possibility that the Federal Reserve will raise interest rates earlier than expected, the USD/CAD pair may experience a rise.

Canada is the world’s fourth-largest exporter of oil, which edged lower on rising concerns that increasing COVID-19 cases in Europe could threaten the economic economy. At the time of writing, U.S. West Texas Intermediate (WTI) crude was trading 3.14% lower at $76.53 a barrel. Lower oil prices lead to lower U.S. dollar earnings for Canadian exporters, resulting in a decreased value of the loonie.

“Our latest estimates suggest that the USDCAD exchange rate is currently overvalued by around 2%, with the fundamental drivers suggesting a ‘fair value’ of 1.22 USD per CAD,” noted analysts at Scotiabank.