Loonie Backed by Oil and Policy Divergence

Key Takeaways:

*BoC expected to cut rates cautiously as sticky 3% core inflation limits room for aggressive easing.

*Domestic economy shows strain with job losses and Q2 contraction, though manufacturing data offers some resilience.

*Firmer oil prices and USD weakness provide external tailwinds, but CAD remains vulnerable if Fed turns more dovish.

Market Summary:

The Canadian Dollar has strengthened in recent sessions, with its gains anchored in relative central bank dynamics and commodity-linked support. The Bank of Canada is widely expected to deliver a 25-basis-point cut, but persistently high core inflation—CPI-trim and CPI-median measures remain near 3.0%—means policymakers are unlikely to signal a fast or aggressive easing path. This contrasts with the Federal Reserve, where markets expect deeper and more sustained cuts, reinforcing policy divergence that works in favor of the Loonie.

Domestic conditions present a more mixed picture. The Canadian economy has shown clear signs of strain, with GDP contracting by 1.6% in Q2 and the labor market shedding 100,000 jobs across July and August, pushing unemployment to 7.1%, its highest level in three years. These factors provide justification for the BoC to cut rates. However, stronger-than-expected August manufacturing sales, which rose 2.5%, highlight pockets of resilience and complicate the case for aggressive monetary loosening. The BoC is thus expected to strike a careful balance, delivering a “dovish cut” while keeping the door open to pause if inflation proves sticky.

Oil prices add another supportive element for the CAD. With WTI holding above $64 per barrel amid heightened geopolitical risks, Canada’s terms of trade have improved, boosting the Loonie at a time when global investors are favoring currencies backed by hard commodities. The CAD’s link to oil remains a structural feature, providing a partial offset to domestic economic headwinds, though also exposing it to downside risk should crude prices reverse.

The broader FX backdrop is also favorable. The U.S. dollar has softened to multi-month lows ahead of the Fed’s decision, amplifying CAD strength. That said, risks remain finely balanced. If the Fed delivers a more dovish surprise than expected, narrowing the policy divergence, or if oil prices falter on oversupply fears, the Loonie’s rally could lose steam. For now, the Canadian Dollar remains supported by a mix of policy divergence, firmer oil, and a weaker U.S. dollar, but its trajectory will hinge on the interplay between domestic data resilience and external macro shifts.

Technical Analysis 

USDCAD, H4: 

USDCAD is testing the 1.3747 support after a sharp pullback from the 1.3875 peak. Recent candles show buyers attempting to stabilize near this zone, but momentum remains weak, leaving the pair vulnerable to further downside. A decisive break below 1.3750 would expose the next supports at 1.3650 and 1.3570, while recovery above 1.3800–1.3820 is needed to ease bearish pressure and refocus attention on 1.3875.

Momentum indicators tilt bearish. RSI is at 28, deep in oversold territory, suggesting selling pressure has been stretched and a short-term rebound could emerge. However, the MACD remains below the signal line in negative territory, confirming bearish momentum and cautioning that any bounce may struggle without follow-through.

Overall, USDCAD sits at a critical support zone. Traders should watch whether 1.3750 holds for a potential corrective bounce, or if a breakdown confirms further downside toward 1.3650.

Resistance level: 1.3750, 1.3875

Support level: 1.3650, 1.3570