During Thursday's Asian trading session, the US dollar weakened against the Canadian dollar for a second consecutive day, touching a low of 1.3792, its weakest level since June 2nd, representing a decline of about 0.1%. Rising crude oil prices, fueled by heightened geopolitical tensions, are providing support for the loonie.
The ongoing stalemate in US-Iran negotiations has extended to the critical Strait of Hormuz, a vital waterway for global oil shipments. Although President Trump has stated that petroleum transport continues through the channel, he has also left room for potential future talks with Tehran. This geopolitical uncertainty is underpinning energy prices, which in turn is bolstering the Canadian dollar against its US counterpart.
Following a missile attack on the UAE, which was attributed to the conflict, Abu Dhabi announced a suspension of all trade with Iran, a move that has further escalated regional tensions. TD Securities notes that the geopolitical landscape remains a primary driver for crude oil, cautioning that there is a significant risk of further escalation in the Iranian conflict. Given the high regional risk and the potential for supply disruptions, the firm believes the geopolitical risk premium for Brent crude will remain elevated, with market participants continuing to price in the possibility of further instability. The stronger oil price directly benefits the commodity-linked Canadian dollar, pushing the USD/CAD pair lower.
On the US dollar front, the minutes from the Federal Reserve's July meeting indicated a preference among officials to raise interest rates promptly if inflation does not show signs of cooling. However, recent monthly data points to subdued price pressures, which has weakened the argument for aggressive tightening. According to the CME FedWatch tool, the probability of a 25-basis-point rate hike in September has dropped to 32.7%, down from 47% a month prior. Simultaneously, the US Treasury announced an expansion of its long-term bond buyback program, doubling it from $20 billion to $40 billion, in an attempt to curb a significant rise in borrowing costs. This, coupled with concerns over the US national debt surpassing $40 trillion, is adding further downward pressure on the dollar. Weak economic data and a repricing of policy expectations have stripped the greenback of its previous support derived from its "relative rate advantage."
State Street Global Advisors, in a report from August 14th, highlighted that despite Canada experiencing a technical recession, having a low policy rate of 2.25%, facing US tariff threats, and having core inflation below target, there are signs of improving growth and high oil prices are providing support. Meanwhile, US growth is healthy but is expected to gradually slow, and easing inflation should help limit Fed tightening expectations, which would narrow the US-Canada interest rate differential. As overall conditions are anticipated to improve, the firm projects that the USD/CAD pair could move into the mid-to-high 1.30s range by late 2026 or early 2027.
ING holds a bearish view on USD/CAD, anticipating a gradual strengthening of the Canadian dollar. Their reasoning is that the resilience of Canada's labor market allows the CAD curve to partially price in hawkish Fed expectations. While the market is pricing in about 15 basis points of rate hikes by the Bank of Canada by year-end, ING does not expect any hikes before mid-2027. With core inflation below target and limited second-round effects from rising energy prices, they see inflation peaking around 2.7%. The bank expects a dovish repricing from the Fed (with no rate hikes). Historically, this has been negative for the CAD relative to other G10 currencies, but a broader weakness in the US dollar could still push the USD/CAD pair below 1.38 by year-end.
In summary, the US dollar has fallen against the Canadian dollar for a second straight session, now trading below the 1.3800 mark. The strengthening of oil prices, driven by escalating geopolitical tensions, is providing support for the loonie. With the US-Iran standoff intensifying and the risk of further escalation in the Iranian conflict, the geopolitical risk premium on Brent crude is likely to remain high. On the US side, weak economic data has compressed the probability of a September rate hike to around 33%, and combined with the Treasury's expansion of its long-term debt buybacks, the dollar is under pressure. As of 14:27 Beijing time on August 20th, the USD/CAD pair was trading at 1.3793/94.
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