The Canadian Dollar (CAD) trades on the back foot against the US Dollar (USD) on Monday as renewed tensions in the Middle East lift the Greenback. At the time of writing, USD/CAD trades around 1.3834, up nearly 0.27% on the day.
Iran’s semi-official Tasnim News Agency reported that Tehran has suspended negotiations with Washington over Israel’s continued military operations in Lebanon against Hezbollah. The report also said Iran has vowed to fully block the Strait of Hormuz.
Earlier on Monday, Iran’s Foreign Ministry spokesperson Esmaeil Baghaei said “a ceasefire in Lebanon is an integral part of any agreement to end the war with the United States.”
Meanwhile, US President Donald Trump attempted to calm markets, saying on Truth Social that he had a “very good call” with Hezbollah representatives and that “all shooting will stop.”
Following Trump’s comments, the US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, trims part of its intraday gains and trades around 99.16 after hitting a daily high near 99.39. The index remains up nearly 0.25% on the day.
Meanwhile, the Canadian Dollar is also weighed down by weak Gross Domestic Product (GDP) data released last week. Bank of Canada (BoC) Senior Deputy Governor Carolyn Rogers said “two quarters of annualized GDP decline meets one recession definition,” while noting that “I think we need to be careful not to put too much weight on any one indicator,” she told a parliamentary committee.
Slowing economic growth could ease pressure on the BoC to raise interest rates even as the inflation outlook deteriorates amid rising Oil prices.
At the same time, inflation in the United States remains well above the Federal Reserve’s (Fed) 2% target, while economic activity continues to hold up, reinforcing expectations that the Fed could keep interest rates higher for longer or even consider raising rates again if inflation pressures intensify.
On the data front, the ISM Manufacturing Purchasing Managers Index (PMI) climbed to 54 in May from 52.7 in the previous month, marking its highest reading since May 2022. However, Canada’s S&P Global Manufacturing PMI eased to 52.9 in May from 53.3 in April.
Looking ahead, attention now turns to labor market data from both the US and Canada due on Friday for fresh clues on the interest-rate outlook.
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money.
When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions.
The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
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