USD/CAD: Loonie Weakens as Greenback Gains Momentum; Downside Risks High

The Canadian dollar weakened against its U.S. counterpart on Wednesday as the greenback surged to a fresh high and the benchmark 10-year U.S. Treasury yield climbed to its highest level since June, mainly due to expectations of at least one rate hike next year and gradual removal of stimulus by the end of the year.

The USD/CAD pair rose to 1.2664 today, up from Tuesday’s close of 1.2685. The Canadian dollar lost over 1.2% last month and further depreciated over 1.0% so far this month.

The dollar index, which measures the value of the dollar against six foreign currencies, was trading 0.52% higher at 94.255- its highest since early November last year. Even though the U.S. debt ceiling dispute threatened the government with a shutdown, the dollar rose.

On Tuesday, the benchmark 10-year U.S. Treasury yield, which moves inversely to bond prices, surged again, reaching its highest levels since June. 10-year Treasury bond yields rose 7.4 basis points to 1.558%. Bond yields on 30-year Treasury notes increased by 9.7 basis points, rising to 2.092%.  That supported the greenback.

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.

“A potentially “hawkish” FOMC plus concerns over the resolution of the US debt ceiling that creates a macro risk-off event could combine to deliver some near-term tactical gains in DXY,” noted analysts at Citi.

“Ultimately, such gains should be faded as – (1) pace of any Fed taper is likely gradual and the Fed, ECB, BoJ, PBoC support risk sentiment well into 2022; and (2) any potential government shutdown beyond September 30th is likely to be temporary. A 91.28 – 93.44 range in DXY remains the base case though FOMC/potential government shutdown could briefly take DXY above the March 2021 high at 93.44 towards 94.50.”

Canada is the world’s fourth-largest exporter of oil, which edge higher on supply concerns. U.S. West Texas Intermediate (WTI) crude futures were trading 0.49% higher at $75.65 a barrel. Higher oil prices lead to higher U.S. dollar earnings for Canadian exporters, resulting in an increased value of the loonie.