US Inflation Data to Set the Tone for USD/CAD

USD/CAD OUTLOOK: NEUTRAL TO BEARISH

• USD/CAD falls modestly on the week, with the Canadian dollar receiving some support from the strong rally in oil prices
• The Loonie could mount a decent recovery if market sentiment stabilizes
• All eyes will be on the U.S. inflation report next week

Most Read: Gold Performance in Midterm Election Years – There’s a Bigger Trend Elsewhere

USD/CAD finished the week moderately lower, down about 0.6% after gaining for the previous three weeks. The Canadian dollar appeared to have benefited from the powerful oil price rally recorded over the past several sessions after OPEC+ decided to cut its production quota, but bearish market tone likely capped its advance.

Looking ahead, the near-term outlook for USD/CAD is somewhat neutral to slightly negative. While the solid U.S. labor market should keep the Fed on a hawkish path, Canada’s fundamentals are also holding up well to withstand additional tightening, meaning that monetary policy should not be a major bullish catalyst for the greenback.

However, one factor that could compromise the above thesis is sentiment. If the mood, which has been cautious of late, worsens, the greenback could resume its advance, with the move powered by safe-haven flows. For traders just starting out, it is important to note that the U.S. dollar tends to trade as a risk-off proxy in times of heightened uncertainty.

Related: US Dollar Reinforced by Sustained Hawkish Fed Speak

In the event market conditions improve after extreme selling activity on Wall Street before the weekend, the Canadian dollar is well positioned to take advantage of oil strength. Crude oil, which is one of Canada’s main exports, has soared roughly 20% since the September low, boosting the country’s terms of trade. In a stable environment, this should be a bullish driver for the Loonie.

Turning our attention to the economic calendar, the September U.S. inflation report due out on Thursday is poised to steal the limelight next week. Annual CPI is expected to cool to 8.1% from August’s 8.3%, but the core gauge is seen accelerating to 6.5% from 6.3%. In any case, the lower the results, the better for the Canadian dollar as soft numbers may prompt the Fed to relent on some of its hawkishness, at the margin.

Conversely, if inflation data surprises to the upside, as it did last month, all bets are off. In this scenario, risk assets could sell off across the board as traders position for an ultra-aggressive FOMC, weighing on high-beta currencies such as the Canadian dollar.

USD/CAD WEEKLY CHART

USD/CAD chart prepared using TradingView

EDUCATION TOOLS FOR TRADERS

• Are you just getting started? Download the beginners’ guide for FX traders
• Would you like to know more about your trading personality? Take the DailyFX quiz and find out
• IG’s client positioning data provides valuable information on market sentiment. Get your free guide on how to use this powerful trading indicator here.

—Written by Diego Colman, Market Strategist for DailyFX