What Are the Factors Affecting USD/CAD?

USD/CAD represents the relationship between the US Dollar (USD) and the Canadian Dollar (CAD), two of the world's major currencies. Analyzing the factors affecting currency pairs can enable traders to make informed decision-making in the forex market. 

In this article, we will cover all factors that affect the USD/CAD currency pair. 

What is USD/CAD?

USD/CAD is a currency pair that represents the exchange rate between the United States Dollar (USD) and the Canadian Dollar (CAD). In this pair, the first currency (USD) is the base currency, and the second currency (CAD) is the quote currency. The exchange rate indicates how much Canadian currency is needed to purchase one US Dollar.

History of USD/CAD 

Over the years, the USD/CAD exchange rate has been influenced by various events. The exchange rate history reveals instances where the Canadian Dollar gained strength against the US Dollar due to rising commodity prices, particularly oil, as Canada is a major exporter of energy products. Conversely, economic downturns or global uncertainties have sometimes led to a strengthening of the US Dollar and a weakening of the Canadian Dollar as investors sought the relatively reduced risk of the USD.

USD/CAD reached one of its highest points of around 1.3860 CAD on March 11, 2023, while it traded around an exchange rate of around 1 from 2012 to 2014. The period between 2019 to 2022 saw the exchange rate dropping from 1.31 to 1.29. This period saw various factors at play, including the economic impact of the COVID-19 pandemic, oil price volatility (given Canada's status as a major oil exporter), and shifts in market sentiment.

Factors affecting USD/CAD

Economic indicators 

Economic indicators such as GDP growth, unemployment rates, and inflation directly impact the USD/CAD exchange rate. Strong GDP growth and low unemployment in the US compared to Canada can appreciate the USD against the CAD, reflecting a stronger US economy. Conversely, relative to the US, high inflation in Canada can depreciate the CAD against the USD, eroding purchasing power and reducing attractiveness to investors. 

For instance, Canada's GDP growth outpaced that of the US in recent years (mostly equal to the US's), leading to periods of CAD strength. In July 2023, Canada's unemployment rate stood at 5.5%, while the US reported an unemployment rate of 3.5%, potentially influencing CAD depreciation against the USD due to a weaker labor market.

Interest rates and monetary policy

The Bank of Canada (BoC) and the US Federal Reserve (Fed) monetary policies drive investor behavior in the USD/CAD market. For instance, in 2023, the BoC raised its interest rates multiple times (to 5%) to manage inflation, causing the CAD to strengthen.

However, the Fed did the same thing and increased its interest rates to 5.5% in July 2023, but the hike was lower than the hike in Canadian rates, appreciating the CAD against USD compared to historical prices. Conversely, if the Fed raised rates while the BoC maintained a more accommodative stance, the USD could appreciate against the CAD.

Oil prices

The relationship between oil prices and the USD/CAD exchange rate is closely tied to the significant dependence of the Canadian economy on oil exports. The Canadian Dollar (CAD) is considered a commodity currency, and oil price fluctuations substantially influence its value. When global oil prices increase, as seen in 2021, Canada experiences an increase in revenue from its oil exports. This improved economic outlook enhances investor confidence in the Canadian economy, prompting them to invest more in CAD-denominated assets. The resulting higher demand for the CAD causes its value to strengthen relative to the US Dollar (USD).

Additionally, rising oil prices can fuel inflationary pressures, prompting the Bank of Canada to consider raising interest rates. The promise of higher returns attracts foreign capital seeking investment opportunities in Canada, further strengthening the CAD against the USD.

A decrease in oil prices (like witnessed in 2020) can lead to USD appreciation against the CAD as Canada's reliance on oil exports could weaken its economy, reducing demand for the CAD. The Canadian central bank might lower interest rates to counter this, making USD investments more appealing due to a wider interest rate gap. Additionally, potential budget deficits from lower oil revenue could undermine the CAD's strength, favoring the USD as a lesser amount would be required to import the same amount of oil from Canada.

Trade relations between the US and Canada

Trade relations between the US and Canada are pivotal in influencing the USD/CAD exchange rate positively and negatively. When there is uncertainty or tension surrounding trade agreements, such as during the NAFTA renegotiation and implementation period in 2020, the exchange rate can experience fluctuations due to market apprehension about the economic impact of potential changes. 

In contrast, establishing stable trade agreements, like the USMCA in 2020, can bolster investor confidence and positively impact the USD/CAD exchange rate. Such agreements provide a sense of security, encouraging cross-border investments and trade, which can lead to an appreciation of the CAD against the USD. On the other hand, any disruptions or concerns in trade relations could lead to a depreciation of the CAD relative to the USD (appreciating the currency) as investors seek refuge in the US Dollar amidst uncertainty.

Geopolitical factors

Geopolitical factors like political stability and global events are important in determining whether the USD appreciates or depreciates against the CAD. When political stability prevails in the United States and Canada, investor confidence is bolstered, attracting foreign investments and potentially driving currency appreciation for USD/CAD. 

However, instances of political turmoil in either nation can breed uncertainty, prompting capital flight and undermining currency value. If there is political unrest in the USD, it could depreciate the USD and vice versa. 

Moreover, pivotal global events like the COVID-19 pandemic also impact the currency. Initially, COVID-19 strengthened the USD, while subsequent variations in government responses and economic outcomes altered the trajectory. 

Correlation with other currency pairs

The correlation that USD/CAD shares with other currency pairs, such as USD/EUR and EUR/CAD, is a vital factor influencing the appreciation or depreciation of the USD and CAD. When USD/CAD shows a positive correlation with USD/EUR, meaning that both USD/CAD and USD/EUR tend to move in the same direction, it suggests that any fluctuation in USD/EUR might have a similar impact on USD/CAD. Hence, if the USD strengthens against the Euro, it may also strengthen against the Canadian Dollar, leading to USD/CAD appreciation. 

On the other hand, if USD/CAD exhibits a negative correlation with EUR/CAD, implying that the two pairs tend to move in opposite directions, shifts in the Euro's value relative to the Canadian Dollar might impact USD/CAD. For instance, if the Euro appreciates against the Canadian Dollar (EUR/CAD decreases), it could result in CAD weakness against the USD, leading to USD/CAD appreciation.

Market sentiment and risk appetite

Market sentiment and risk appetite reflect investors' attitudes towards risk and potential returns. Hence, they are crucial in determining whether the USD appreciates or depreciates against the CAD.

For example, During the peak of the COVID-19 pandemic, a prevailing risk-off sentiment dominated global markets. Investors were concerned about economic uncertainty and sought less risky assets, often including the USD. This increased demand for the USD as a currency and led to its appreciation against several counterparts, including the CAD. 

The CAD, being perceived as a riskier asset due to its association with commodities and trade, experienced a decrease in demand as investors prioritized capital preservation over potential yield.

Conversely, as economies recover from the pandemic's impact and global risk appetite improves, investors might shift towards higher-yielding and riskier assets, including the CAD. In this scenario, the CAD could gain strength against the USD. As risk sentiment turns more positive, investors become more comfortable taking on risk, which can lead to increased investments in countries with stronger economic prospects, like Canada. This surge in demand for CAD may lead to its appreciation against the USD.

Economic disparities between the US and Canada

Economic disparities reflect differences in economic performance, growth prospects, and monetary policies, contributing to whether the USD/USD appreciates or depreciates.

In 2023, as the global economy recovered from the pandemic's impact, the United States experienced a notable rebound in economic activity. This recovery was characterized by robust GDP growth, increased consumer spending, and a rejuvenated job market. Such positive economic indicators can lead to heightened investor confidence in the US economy and its currency, potentially driving USD strength against the CAD.

Furthermore, disparities in trade balances, inflation rates, and industry performance can all affect investor perceptions and market sentiment, influencing demand for each currency. If the US exhibits stronger economic fundamentals compared to Canada, it can lead to USD appreciation against the CAD and vice versa.

Macroeconomic data releases

Macroeconomic releases provide critical insights into the economic health of both countries, influencing investor sentiment and currency demand. When data, such as the Canadian employment report in June 2023, surpasses expectations, it suggests a stronger economy and triggers increased demand for CAD, appreciating the currency against the USD. Conversely, data that falls short of expectations can weaken the currency as investors react to perceived economic vulnerabilities.

For example, the non-farm payroll report for the US in 2023 gave higher-than-expected results. This led to a currency appreciation for the USD against the CAD due to a positive macroeconomic data release as investor confidence increased, and they saw a potential for higher returns in the USD. 

Technological advancements and algorithmic trading

Technological advancements and the rise of algorithmic trading are now significant factors influencing the USD/CAD exchange rate. High-frequency algorithmic trading, driven by powerful computer algorithms, introduces rapid and substantial intraday fluctuations. These algorithms analyze economic indicators, news releases, and technical patterns to execute trades at lightning speed. Notably, news releases that deviate from market expectations can trigger instant algorithmic responses, leading to quick price changes in the USD/CAD rate. 

Positive economic reports, such as better-than-expected employment data from the US, can drive rapid USD appreciation due to heightened investor optimism. Conversely, unexpected events can prompt algorithmic systems to exit rapidly, causing temporary USD/CAD depreciation.

** Past performance is not an indicator of future returns

Risks associated with trading USD/CAD

The currency pair's volatility can lead to sudden and unpredictable price movements, exposing traders to potential losses. Economic data releases, interest rate changes, and geopolitical events can swiftly impact the exchange rate. The interplay between the US and Canadian economies introduces complexities, where unexpected shifts in one country's economy can influence the other. Commodity price fluctuations (particularly oil), especially when there is a mismatch between the demand and supply, like during a crisis, can add an extra layer of uncertainty to USD/CAD trading.

Hence, traders should carefully develop strategies, set stop-loss orders, and employ risk management techniques to navigate these risks effectively and enhance their chances of success in USD/CAD trading.

Consider all these factors while trading USD/CAD 

Traders need to be aware of all these factors while trading the currency pair to conduct successful trading in the forex market. While the USD/CAD is a major currency pair to trade, traders must also consider the associated risks.