The Canadian dollar and forex trading: understanding the relationship
The Canadian dollar (CAD) is one of the eight major currencies that account for over 80% of the trade volumes in the global forex market. The Canadian dollar is often called the “loonie” since it appears to be a loon on the back of the currency coin. Being one of the world’s major currencies, the Canadian dollar is the 6th most-held currency as reserves. The currency ranking of CAD is a kind of anomaly as the economy stands at the 10th position in the world in terms of US dollars GDP. The country is also comparatively low compared to other major economies in terms of population. The Bank of Canada supports the Canadian dollar, which tries to find a proper balance between the policies promoting economic growth and employment while controlling inflation.
In this comprehensive guide, we will connect forex trading and the Canadian dollar and see how different factors like commodity prices, interest rates, and the US Dollar are related to the currency.
Overview of the Canadian Dollar
The historical background of the Canadian dollar provides a unique viewpoint that shows the growth and development of Canada as an economy. The evolution of the Canadian dollar has seen various phases, from the pre-colonial origins under the British and French through the two world wars and the Great Depression.
Today, the Canadian dollar comprises 100 cents and is often described as C$ or CAD to differentiate the currency from other national currencies dominated by the dollar. CAD is a benchmark showing the currency’s hold in the reserves by multiple global central banks.
Being a versatile currency, CAD is influenced by various factors like the monetary policy of the Bank of Canada, consumer price index, gross domestic product, international relationships, foreign acquisitions, unemployment rate, regulated releases of statistical economic data, oil effects, political conditions, and geopolitical events.
Canadian Dollar and Commodity Prices
A correlation between the Canadian dollar and commodity prices helps traders understand, analyze, and predict market movements. Commodity prices affect the value of Canadian dollars. The correlation between the Canadian dollar and the world’s essential, necessary commodity, oil, may break daily. Still, in the long run, it has been extremely strong since the value of the Canadian dollar has a valid reason to be hyper-sensitive to the oil’s price. As an oil exporter, Canada gets severely hurt when the price of oil falls. The country is also the world‘s fourth-largest producer of crude oil, and the size of its oil reserves is third in the world. The price of oil and other commodities is a prominent indicator of the value of the Canadian Dollar for traders. The currency pair used in forex and commodity trading is USD/CAD, which is heavily affected by oil prices. When the prices increase, USD/CAD falls, and vice versa.
The Canadian dollar is often described as a commodity or Petro currency since the correlation between CAD value and commodity prices features a regular commentary that can be seen in statistical data at any frequency. The term commodity currency is also given due to the country’s significant raw material exports and rich natural resources. Moreover, being a commodity exporter, any increase in commodity prices acts as an early alert for future growth and inflation in the country. Hence, the inflation targeters react to it by setting monetary policies. The traders know this pattern, and they tend to bid up the price of the Canadian dollar when the prices of commodities rise.
Canadian Dollar and Interest Rates
A country’s monetary policy is closely related to the exchange rate regime. The interest rates affect the value of CAD. Hence, countries with fixed exchange rates have fewer prospects for an independent monetary policy than the ones with flexible exchange rates. A high-interest rate in Canada can increase the demand of foreign investors for Canadian dollar-backed securities. Nevertheless, the rate of returns dramatically depends on the currency’s expected future performance. If investors anticipate a fall in the value of CAD, they will demand a higher interest rate on the securities that are backed by Canadian dollars.
Essentially, interest rates substantially affect the Canadian dollar’s value. Higher interest rates attract more foreign investment, which increases the demand for CAD, thereby increasing the value of Canadian dollars many consider this the right time to start forex trading. Conversely, a lower interest rate can decrease the value of CAD. This occurrence may be complicated by different factors that affect exchange rates and the value of the Canadian dollar. There is one complicated relationship between inflation and higher interest rates. Bank of Canada may raise the interest rate due to rising inflation to cool off the overheated economy. However, if the economy gets inflated too quickly, it can potentially devalue the Canadian dollar faster than the interest rates can compensate.
Interest rates also affect forex trading as high rates encourage forex traders to buy more currencies leading to rising exchange rates. However, when the rates are cut, traders are willing to offload the currency, which decreases the exchange rate. Forex trading can be done profitably if timely and thorough research is done before any movements in the interest rates, even when exchange rates change suddenly. It is recommended that traders use reliable Canadian forex brokers to get market information in real-time and make sound trading decisions.
Canadian Dollar and the US Dollar
Interest rates can affect the exchange rate between the Canadian dollar and the US dollar. The interest rate differentials between these two currencies directly impact the exchange rate. When the Canadian interest rates are higher than those in the United States, CAD essentially appreciates compared to USD. This is because Canada’s high-interest rates make CAD look more attractive to foreign investors willing to earn higher returns. Due to this, investors purchase more CAD, pushing the demand for the currency and appreciating its value relative to US dollars.
The two currencies (CAD and USD) are closely linked because CAD is tied to global oil prices that affect the US. If the demand for oil increases in the US, its trade terms improve since oil becomes relatively more valuable than other oil producers. Because of this, CAD value surges against the USD. Oil being the essential Canadian export to the US, there is an excellent dependency between CAD and USD. However, the Canadian dollar can still sustain the currency without any significant relationship with the US dollar, even though it is hugely dependent on the market forces in the US.
Macroeconomic factors such as inflation and GDP significantly impact forex trading in CAD or USD. International trades, such as trade surpluses and deficits, also play an essential role in the forex market. Political news and US economic data determine the overall health of an economy and, consequently, the value of the country’s currency. Forex traders monitor political events and news to anticipate changes in the government’s macroeconomic policies. Central bank decisions also significantly impact the interest rates and hence, are keenly monitored by the forex traders to keep pace in the fast-moving and competitive world of trading.
Exchange rates are notoriously challenging to predict. There are various models and factors to consider that may help short-term forex traders place trades profitably using the Canadian dollar (CAD). Although Canada is not a large country and is also not one of the major exporters of commodities, the economic vitals have more or less been stable. Canada is becoming a more viable alternative to the US dollar due to the country‘s exposure to different commodities, making Canada a meaningful producer of grains, wood products, minerals, and petroleum. The trade flows from these exports also influence investor sentiments regarding CAD. All in all, the demographics of Canada are suitable for long-term economic forex trade compared to global standards.
Harvey is the FinanceWhile’s passionate news writer. Before joining our team, he was a freelance writer and had written a number of articles related to finance and economics for foremost publications and news sites. He is an avid traveler. In leisure, he loves to travel and explore new places.