Recent Declines in Oil Prices
The Canadian Dollar is influenced by factors such as Bank of Canada interest rates, Oil prices, economic health, inflation, trade balance, and the US economy’s condition. Bank of Canada decisions on interest rates directly impact the CAD, with higher rates usually strengthening the currency. Oil prices are crucial for the CAD due to Canada’s significant Oil exports. High inflation tends to prompt rate hikes, making the CAD more appealing. Economic indicators like GDP and employment also significantly influence the CAD’s strength.
The outlook for USD/CAD appears set to continue its downward trend into early 2026, as the pair hovers near the 1.3770 level. We see the key driver as the diverging policy paths between a softening U.S. Federal Reserve and a more resolute Bank of Canada. This suggests that strategies favouring a stronger Canadian dollar, such as buying put options on the USD/CAD pair, are worth considering in the coming weeks.
The Fed’s dovish stance has been reinforced by recent data, with the November 2025 U.S. Consumer Price Index coming in cooler than expected at 2.8% year-over-year. This has solidified market bets, with federal funds futures now pricing in over a 70% probability of a rate cut by the end of the first quarter of 2026. This environment continues to weigh on the U.S. dollar’s value.
Canada’s Economy Shows Persistence
Conversely, Canada’s economy is showing more persistence, as seen in the latest Labour Force Survey which added a solid 45,000 jobs last month. This strong employment figure gives the Bank of Canada little incentive to signal imminent rate cuts, supporting the Canadian dollar’s relative appeal. We believe this policy gap between the two central banks will remain the dominant theme for the currency pair.
The primary risk to this view is the recent weakness in crude oil prices, which undermines the commodity-linked loonie. WTI crude has struggled to stay above $75 per barrel, a notable drop from its highs earlier in 2025, which may limit the Canadian dollar’s advance. This introduces volatility, making options strategies that define risk, such as put spreads, potentially more suitable than directly shorting futures.
We can look back to the 2014-2016 period as a reminder of how a steep fall in oil prices can heavily pressure the Canadian dollar, sometimes overpowering other factors. That history suggests that while the central bank divergence is powerful, a sustained decline in energy markets can still cap the loonie’s strength. Therefore, traders should watch upcoming oil inventory data and OPEC+ announcements with keen interest.
