Canadian Dollar strengthens despite hawkish Fed rhetoric

The USD/CAD pair edges lower to around 1.3890 during the Asian trading hours on Monday. Renewed tensions between the US and Iran boost crude oil prices, supporting the commodity-linked Canadian Dollar (CAD) against the US Dollar (USD). Traders await employment reports from the US and Canada, due on Friday.

US officials said on Sunday that US forces struck two Iranian launchers on Iran's Larak island, marking the first known American strikes on Iran since late July, per the BBC.

Irans Islamic Revolutionary Guard Corps (IRGC) stated that Sunday's attack killed and wounded several people, and vowed “response and punishment”. Iranian military later said it had launched an attack on US military targets in Jordan. It is worth noting that Canada is a major oil-exporting country, and high crude oil prices generally have a positive impact on the CAD.

However, hawkish Federal Reserve (Fed) rhetoric could provide some support to the Greenback. Fed Chairman Kevin Warsh warned on Friday at the Jackson Hole economic symposium that inflation is not slowing significantly, and that unless policymakers become confident it is, the central bank has “work to do.”

Scotiabank strategists note that recent Canadian releases have consistently beaten expectations, suggesting that “solid data is perhaps already priced in to the CAD to a degree, given that domestic data have generally outperformed expectations in recent weeks.” Even so, they add that the upcoming growth figures “may add modestly to CAD tailwinds in the short run,” reinforcing the currencys underlying support without materially shifting the broader narrative.

Fed Chair Warsh delivered a notably more hawkish-leaning message, with the FXS Speechtracker score at 7.4/10 compared to the established baseline of 6.5/10, underscoring heightened concern about price stability. The insistence that the Fed must be confident underlying inflation is moving to objective or “we have work to do,” combined with comments that financial conditions are not restrictive and credit and loan markets show few signs of policy restraint, points to a bias toward further tightening if inflation progress stalls. Warshs emphasis that summer inflation data are better but do not yet signal a meaningful change in underlying trends, alongside a firm reaffirmation of the 2% PCE target and a predominant focus on prices, reinforces a vigilant stance that is supportive of the Dollar and negative for risk-sensitive FX if markets price in additional policy action.

The FXS Fed Sentiment Index was unchanged, moving 0.00 points to a still-elevated level of 129.70, which keeps the policy tone firmly in hawkish territory despite the lack of incremental shift in the gauge. The combination of a high FXS Fed Sentiment Index level and an above-baseline FXS Speechtracker score suggests that markets will continue to interpret Fed communication as leaning toward tighter policy, with potential upside for the Dollar against lower-yielding currencies if incoming data fail to confirm a durable disinflation trend.

In the daily chart, USD/CAD retains a mildly bearish near-term bias as spot holds just under the 20-day Bollinger middle band and the 100-day simple moving average (SMA). The pair has retreated from the upper half of the recent Bollinger envelope toward its midline, while the Relative Strength Index (RSI) at 45.6 slips below the neutral 50 mark and hints at fading bullish momentum rather than outright selling pressure.

On the topside, initial resistance comes at the 20-day Bollinger SMA middle band at 1.3900, followed by the 100-day SMA at 1.3915, with a more decisive barrier at the 20-day Bollinger upper band near 1.4045. On the downside, the next significant support is located at the 20-day Bollinger lower band around 1.3750, where buyers are likely to emerge if the current soft tone extends into a deeper corrective pullback.

(The technical analysis of this story was written with the help of an AI tool. Know more.)

The key factors driving the Canadian Dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of Oil, Canada‘s largest export, the health of its economy, inflation and the Trade Balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – with risk-on being CAD-positive. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian Dollar.

The Bank of Canada (BoC) has a significant influence on the Canadian Dollar by setting the level of interest rates that banks can lend to one another. This influences the level of interest rates for everyone. The main goal of the BoC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former CAD-negative and the latter CAD-positive.

The price of Oil is a key factor impacting the value of the Canadian Dollar. Petroleum is Canadas biggest export, so Oil price tends to have an immediate impact on the CAD value. Generally, if Oil price rises CAD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Oil falls. Higher Oil prices also tend to result in a greater likelihood of a positive Trade Balance, which is also supportive of the CAD.

While inflation had always traditionally been thought of as a negative factor for a currency since it lowers the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to lead central banks to put up interest rates which attracts more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in Canadas case is the Canadian Dollar.

Macroeconomic data releases gauge the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment but it may encourage the Bank of Canada to put up interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.