The US dollar weakened against the Canadian dollar for a second consecutive session during Asian trading on Friday, with the USD/CAD pair retreating to the vicinity of 1.4200. A rise in international crude oil prices improved the overall performance of commodity-linked currencies, attracting capital flows to the Canadian dollar. While the US dollar found underlying support from expectations of Federal Reserve interest rate hikes, it was insufficient to prevent a short-term pullback in the currency pair.
As one of the world's major crude oil exporters, energy products constitute Canada's most significant source of foreign exchange revenue. When international oil prices increase, the anticipated improvement in Canada's export earnings typically propels the Canadian dollar higher. The recent appreciation of the loonie was primarily influenced by renewed tensions in the Middle East, prompting markets to reprice risks to global energy supply.
A cargo ship near Oman was suspected of being attacked, leading the United Nations' International Maritime Organization to subsequently suspend related shipping security operations in the Strait of Hormuz. Concurrently, two US officials stated that Iran fired upon a cargo ship attempting to transit the Strait of Hormuz, with Iran later warning that vessels not following designated routes could not be guaranteed safety. Market concerns over escalating regional tensions drove international oil prices higher, further bolstering the Canadian dollar.
Nevertheless, the US dollar maintained considerable overall resilience. The latest US inflation data revealed that the Personal Consumption Expenditures (PCE) price index rose 4.1% year-over-year in May, a significant acceleration from April's 3.3% and marking the first time in nearly three years it has re-crossed the 4% threshold. Rising energy costs contributed to the broader inflationary pressure, reinforcing market expectations that the Federal Reserve might implement further monetary policy tightening within the year.
Simultaneously, the core PCE price index, which the Fed closely monitors, increased 3.4% year-over-year, surpassing the previous reading of 3.3% and reaching its highest level since October 2023. This indicates that underlying US inflation remains notably persistent. The sustained high inflation level has elevated market expectations for interest rates to remain elevated for an extended period, providing substantial support for the US Dollar Index.
According to the CME FedWatch Tool, markets currently price in approximately a 63.4% probability of a Fed rate hike at the September policy meeting. With the US dollar supported by policy expectations and the Canadian dollar benefiting from rising oil prices, the short-term direction of USD/CAD is caught in a tug-of-war between opposing forces. Subsequent market focus will remain on developments in the Strait of Hormuz, trends in international oil prices, and US economic data releases to gauge the pair's next directional phase.
Technical Analysis Perspective
From a daily chart perspective, USD/CAD has entered a consolidation phase following its retreat from recent highs but continues to trade above its medium to long-term moving averages, suggesting the broader bullish trend has not been entirely negated. The immediate support is situated around 1.4180; a break below this level could see the pair test the 1.4120 and 1.4050 zones. On the upside, resistance levels to watch are at 1.4250, 1.4300, and 1.4360. A decisive move back above 1.4250 could empower bulls to once again challenge recent highs. Daily momentum has moderated, but the overall bias leans towards consolidation at elevated levels.
On the 4-hour chart, the pair has declined for two consecutive sessions, with short-term moving averages beginning to flatten. The MACD indicator hovers near the zero line, with the green histogram expanding moderately, indicating a slight short-term advantage for sellers. However, considering the relatively robust fundamental backdrop for the US dollar, the downside for the pair may be limited. A successful break above 1.4250 could reignite the rebound, testing resistance near 1.4300. Conversely, a drop below the 1.4180 support could lead to a further decline towards the 1.4120 area in search of support.
Market Outlook Summary
Rising international oil prices have improved Canada's export outlook, providing support for the Canadian dollar and driving a consecutive decline in USD/CAD. However, persistent US inflation above target levels keeps expectations for further Federal Reserve rate hikes firmly in place, preserving the US dollar's fundamental advantage. In the near term, the currency pair's trajectory will be shaped by the interplay between oil price movements and US dollar strength. Should Middle East tensions persist and drive oil prices higher, the Canadian dollar may maintain relative strength. Conversely, if US economic data continues to show resilience and the Fed maintains a hawkish stance, the downside for USD/CAD is likely to be constrained.
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