The US Dollar against the Canadian Dollar fell for a second consecutive day during Friday's Asian trading session, edging down to near 1.3920. This decline was primarily driven by a weaker US Dollar and shifting market expectations for Federal Reserve policy. The latest US inflation data came in significantly below the levels markets had feared, causing the greenback to lose some of its interest rate advantage in the short term. However, the drop in USD/CAD was not smooth, as the Canadian Dollar, a typical commodity currency, is highly sensitive to crude oil prices. Recent pullbacks in international oil prices have limited the loonie's upside potential, preventing a more decisive move lower.
The catalyst for the dollar's weakness was the US Producer Price Index (PPI) for July. Data from the Bureau of Labor Statistics showed the PPI for final demand was unchanged month-over-month, following a downwardly revised decline of 0.1% in June. This was notably below the market consensus for a 0.2% increase. The year-over-year rate stood at 4.7%. The core PPI, which excludes food and energy, rose 0.2% month-over-month, also undershooting the 0.3% forecast, with an annual increase of 4.2%. This suggests that price pressures at the producer level have not expanded further for the time being, alleviating market concerns about the Fed needing to tighten monetary policy aggressively in the near term.
Where to focus for direction
The shift in rate expectations directly impacted USD/CAD. Interest rate market data indicates that investors now see the probability of a Fed rate hike in September at roughly 34.8%, a decline from the approximately 40% level seen after the PPI release. The market's previously more concentrated expectation for a policy adjustment in September is now being redistributed towards October and December. This is capping further upside in short-term US yields, putting downward pressure on the valuation of the US Dollar.
However, the US economy has not shown any clear signs of faltering. Upcoming data on US retail sales and the University of Michigan consumer sentiment index will provide new directional cues for the market. If retail sales remain resilient, it could offset some of the dollar's pressure stemming from cooling inflation. Conversely, a significant miss on consumer spending could reinforce the thesis that the Fed will delay rate hikes, further weighing on USD/CAD.
Domestically in the US, the combination of cooling inflation and marginal changes in the labor market is forming a noteworthy dynamic. The number of initial jobless claims recently rose to 209,000, up from the previous week's 200,000 and slightly above market expectations. While this level is still historically low, if the labor market continues to cool, the market may further reduce the probability of a Fed rate hike, which would more significantly compress the dollar's interest rate premium.
In contrast, Canada's economic fundamentals are showing some improvement. The country added 75,100 jobs in July, far exceeding the market's forecast of 16,500. The unemployment rate dropped to 6.4%, its lowest level since July 2024. This marks the third consecutive month of job growth, suggesting that the Canadian economy's previous period of weakness is being repaired. At the same time, the growth rate of average hourly wages for permanent employees slowed from 3.7% in June to 3.0%, indicating that the labor market improvement is not significantly worsening wage inflation.
The Bank of Canada (BoC) held its policy rate steady at 2.25% in July, stating that the economy is gradually recovering. The central bank estimated that the economy likely grew at an annualized rate of about 2.5% in the second quarter and revised its 2026 inflation forecast upwards to 2.5% from a previous 2.3%. This shows that policymakers are still seeking a balance between economic recovery and price pressures. Canadian inflation itself, however, does not provide a particularly strong reason for the BoC to hike rates further. Canada's CPI inflation rate slowed to 2.8% year-over-year in June, down from 3.2% in May, primarily due to lower gasoline prices. Excluding gasoline, the inflation rate was around 2.2%, and core inflation measures also declined. This cooling inflation means the BoC has no urgent need to rapidly raise interest rates to tame price pressures in the short term, limiting the loonie's interest rate advantage.
Therefore, the current situation for USD/CAD is not a simple case of "US cooling inflation equals a sustained rally in the Canadian dollar." While the Canadian economy is improving, BoC policy remains cautious. Meanwhile, crude oil price movements have a more direct impact on the loonie. As a major energy exporter, rising oil prices typically improve Canada's terms of trade and boost energy export revenues, supporting the currency. Conversely, falling oil prices weaken this support.
From a market sentiment perspective, USD/CAD is currently in a tug-of-war between a weak US Dollar and a pullback in oil prices. The dollar side is suppressed by cooling US inflation and declining expectations for a Fed rate hike, while the loonie side is constrained by weaker crude oil prices and the BoC's cautious stance. As a result, although the pair has broken below 1.4000, further downside requires a new catalyst. Key factors to watch next include US retail sales, US Treasury yields, comments from Fed officials, and changes in international oil prices. Additionally, Canadian data on July manufacturing shipments and wholesale trade will provide fresh economic clues. The Canadian economic calendar shows that manufacturing shipments and wholesale trade data will be released on August 14th, with the next important inflation data due on August 17th.
Why the 1.3900 level is critical
On the daily chart, USD/CAD has been steadily declining from above 1.4100 in recent sessions and is now trading near 1.3920, with a clear short-term bearish bias. The 1.4000 psychological level has transitioned from support to a key resistance overhead. If the price cannot reclaim this level, sellers are likely to remain in control. The first support level to watch is around 1.3900. A decisive break below this could open the way for a move towards the 1.3850–1.3820 area. If the downtrend extends, the 1.3750 area becomes the next significant support level. On the upside, resistance is at 1.4000 and 1.4050. A break back above 1.4050 would suggest a significant repair of the recent downtrend, potentially leading to a retest of the 1.4100 region. In terms of momentum, the pair has weakened for two consecutive sessions, indicating short-term selling pressure is dominant. However, if oil prices fall simultaneously, a technical bounce near 1.3900 is possible.
On the 4-hour chart, USD/CAD has formed a clear downtrend structure, trading below its short-term moving averages, with each bounce being capped by lower highs. The 1.3950–1.4000 zone forms the first resistance area. If the price bounces and is rejected again in this zone, the short-term bearish structure remains intact. The 1.3900 level is the most immediate technical support. A 4-hour candle closing effectively below this level could open the path towards 1.3850 and even 1.3820. Conversely, if significant buying interest emerges near 1.3900, pushing the price back above 1.3950, the pair could enter a period of sideways consolidation, with a potential challenge of the 1.4000 resistance. Technically, the direction of oil prices and the US Dollar Index will have a significant impact on the validity of any breakout, making it important to consider these factors alongside the exchange rate itself.
Summary of the outlook
The core contradiction for USD/CAD is that cooling US inflation is eroding the dollar's interest rate advantage, while improving Canadian economic and employment data provide some fundamental support for the loonie. The flat US July PPI has reduced the probability of a September Fed rate hike to around 34.8%, putting short-term pressure on the dollar. Canada's addition of 75,100 jobs in July, with the jobless rate falling to 6.4%, has further improved the market's assessment of the Canadian economy's resilience. However, the Canadian dollar is not without risks. With Canadian inflation falling to 2.8% in June and the BoC maintaining its policy rate at 2.25%, Canadian monetary policy currently lacks a clear tightening impetus. At the same time, crude oil prices will continue to be a major external variable for USD/CAD. Rising oil prices would favor the loonie and push USD/CAD lower, while a sustained drop in oil prices could weaken the commodity-linked currency's advantage. Looking ahead, 1.3900 is the most critical short-term support level for USD/CAD, while 1.4000 is the key resistance level where bulls and bears will vie for control. A break below 1.3900 could push the pair towards the 1.3850–1.3820 adjustment zone. A move back above 1.4000 could temporarily relieve the recent bearish pressure. In summary, against the backdrop of falling US rate hike expectations, improving Canadian employment, and lingering oil supply risks, USD/CAD maintains a short-term bearish bias, but a strong technical battle is expected near 1.3900. The factors that will ultimately determine the trend's sustainability are US consumer data, Fed policy expectations, Canadian inflation, and whether crude oil prices can regain strength.
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