USD/CAD: Loonie Strengthens as Omicron Fears Ease; All Eyes on BoC Rate Decision

The Canadian dollar strengthened against its U.S. counterpart on Tuesday as fears over the Omicron variant of coronavirus eased worldwide; also, investors await the Bank of Canada’s monetary policy announcement on Wednesday, where it may address market expectations of successive rate hikes next year.

“USDCAD has moved up in a straight line since late October to retest the 1.28 area-where price has struggled consistently this year. The extended rally in the USD, and especially the rally through the upper 1.26s, has eliminated more significant downside risks for the USD into year-end, we have to think now. But the USD rally is looking stretched and oscillator signals are suggesting that the move up has run out of steam—or is close to it,” noted Shaun Osborne, Chief FX Strategist at Scotiabank.

“Friday’s move to a new cycle high was not matched by various oscillator signals and without that “confirmation” the move up looks increasingly prone to a reversal. Key short-term support is 1.2770 today and a break under what is the base of the channel in place since early November will target a drop back to the high 1.25s/low 1.26s.”

Today, the USD/CAD pair fell to 1.2767 down from Monday’s close of 1.2754. The Canadian dollar hit its lowest level in over two months last week. After gaining about 2.3% in October, the loonie weakened over 3.1% last month.

Canada is the world’s fourth-largest exporter of oil, which edged higher on improved sentiment as fears over the Omicron variant eased worldwide. The top U.S. infectious disease official told CNN that there is no indication yet that the cases of Omicron are more severe than mild, Reuters reported.

At the time of writing, U.S. West Texas Intermediate (WTI) crude was trading 2.98% higher at $71.59 a barrel. Higher oil prices lead to higher U.S. dollar earnings for Canadian exporters, resulting in an increased value of the loonie.

On Wednesday, the Bank of Canada will announce its decision on the target for the overnight rate, where it could try to achieve a balance between employment gains and Omicron risks.

“Omicron’s emergence will mean the BoC will tread carefully, but strong growth, a booming jobs market and bubbling inflation pressures suggest we remain on course for four rate hikes in 2022. We expect only a limited impact on CAD, which should remain almost solely driven by external factors, at least for now,” noted Francesco Pesole, FX Strategist at ING.

“All in all, we think the BoC won’t surprise markets and that CAD will be only marginally impacted by the policy meeting this week, leaving the currency almost solely driven by external factors for now. Barring a major setback to the global economy due to the Omicron variant, we still expect USD/CAD to consistently trade below 1.25 in 2022.”

The dollar index, which measures the value of the dollar against six foreign currencies, was trading nearly flat at 96.412. The Invesco DB US Dollar Index Bullish Fund, which is designed for investors who want a cost-effective and convenient way to track the value of the U.S. dollar relative to a basket of the six major world currencies – the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc – closed 0.17% higher at 25.82 on Monday.

The last minutes of the U.S. Federal Reserve meeting confirmed market expectations that the Fed will raise rates sooner than other major central banks. The greenback hovers near the 16-month high 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.