Canadian Dollar bears retain control near August 7 low amid US-Canada rate gap/trade war

The USD/CAD pair oscillates in a narrow band during the Asian session on Friday, trading below the 1.4000 psychological mark or the highest level since August 7, touched earlier this week. Nevertheless, spot prices remain on track to register gains for the second straight week and seem poised to prolong an over one-week-old uptrend amid a supportive fundamental backdrop.

The Canadian Dollar (CAD) has been underperforming against its American counterpart due to the widening US-Canada rate gap, which, in turn, continues to act as a tailwind for the USD/CAD pair. In fact, the Bank of Canada (BoC) maintained its key policy interest rate at 2.25% earlier this month. The US Federal Reserve (Fed), on the other hand, raised its benchmark rate for the first time in over three years, by 25 basis points (bps) to a range of 3.75%–4.00% on Wednesday.

CAD underperforms as Fed–BoC spread widens and USD stays rich

Strategists at Scotiabank note that the renewed widening in US–Canada rate differentials is weighing heavily on the Loonie. With the “Fed/BoC policy rate differential back to 175bps, where it spent much of last year, wider front-end spreads account for the CAD’s softness and underperformance.” They add that their “fair value model indicates an equilibrium exchange rate of 1.3894, indicating that there is a degree of USD overvaluation in current spot rates but, with little prospect of that gap narrowing anytime soon, the CAD may find it hard to recover meaningfully for now.”

Adding to this, ongoing US-Canada trade tensions turn out to be another factor undermining the commodity-linked Loonie. The US imposed steep 50% tariffs on approximately $20 billion worth of Canadian goods on August 22, while Canada implemented retaliatory tariffs ranging from 15% to 50% on roughly $20 billion worth of US goods on September 8. This offsets the recent surge in crude oil prices and fails to ease the bearish pressure surrounding the commodity-linked Loonie.

Meanwhile, Fed Chair Kevin Warsh’s focus on inflation calmed the recent selloff in the fixed-income market and dragged US bond yields away from multi-year highs. This keeps the US Dollar (USD) on the back foot and acts as a headwind for the USD/CAD pair. That said, the US central bank's hawkish outlook, signaling one more rate hike this year, and persistent geopolitical uncertainties should act as a tailwind for the safe-haven buck, which, in turn, favors USD/CAD bulls.

USD/CAD daily chart

Technical Analysis:

The USD/CAD pair a constructive near-term bullish bias following the post-Fed breakout through the 1.3940 confluence – comprising the 100-day Simple Moving Average (SMA) and the 38.2% Fibonacci retracement level. Bulls now await acceptance above the 50.0% retracement at 1.3993 before positioning for further move up to the 61.8% level at 1.4054 and then 78.6% at 1.4141, ahead of the cycle high anchor near 1.4251.

On the downside, the 1.3940 confluence resistance breakpoint now seems to act as an immediate support. This is followed by deeper structural floors at 1.3857 and 1.3736, levels that would need to give way to weaken the current bullish tone.