- USD/CAD rose above 1.4400 as the US dollar hit a new two-year high.
- The Fed is expected to go through a gradual rate-cutting cycle this year.
- Investors are awaiting US ISM Manufacturing PMI data for December.
The USD/CAD pair rose to around 1.4420 in European trading on Thursday. The loonie pair is rising as the U.S. dollar (USD) dominates its European and North American peers on expectations that the Federal Reserve will cut interest rates at a slower pace this year than in 2024.
The US Dollar Index (DXY), which tracks the value of the US dollar against six major currencies, hit its highest level in more than two years at 108.60.
Fed officials said they are confident in the U.S. economic outlook and will cut interest rates less this year. The latest dotplot shows that policymakers generally see the federal funds rate heading toward 3.9% by 2025, suggesting multiple rate cuts this year.
Investors will be watching a number of U.S. labor market-related economic indicators released next week in search of further rate cuts. These economic indicators will provide an indication of the current demand for labor by U.S. employers.
But before that, the US dollar will be guided by December ISM Manufacturing PMI data to be released on Friday. The PMI report now expects manufacturing activity to fall from the previously announced 48.4 to 48.3, suggesting a slightly faster pace of contraction.
Meanwhile, the outlook for the Canadian dollar (CAD) remains bearish as the Bank of Canada (BoC) is expected to continue further monetary easing. Central bank officials are concerned about the increased risk that inflation will fall below the central bank's 2% target.
US Dollar Frequently Asked Questions
The United States Dollar (USD) is the official currency of the United States and the “de facto” currency of many other countries, circulating alongside local paper currency. The US dollar is the most frequently traded currency in the world, accounting for over 88% of global foreign currency trading volume, or an average daily trading volume of $6.6 trillion, according to 2022 data. . After World War II, the US dollar took over. From the British pound as the world's reserve currency. For most of its history, the U.S. dollar was backed by gold until the 1971 Bretton Woods agreement abolished the gold standard.
The most important single factor influencing the value of the US dollar is the monetary policy formed by the Federal Reserve System (Fed). The Fed has two responsibilities: achieving price stability (controlling inflation) and promoting full employment. The main tool to achieve these two goals is to adjust interest rates. If prices rise too fast and inflation exceeds the Fed's 2% target, the Fed will raise interest rates to support the value of the U.S. dollar. If inflation falls below 2% or unemployment is too high, the Fed could cut interest rates, which would weigh on the dollar.
In extreme circumstances, the Federal Reserve could also print more dollars and implement quantitative easing (QE). QE is a process by which the Fed significantly increases the flow of credit in a stalled financial system. This is a non-standard policy tool used when credit is exhausted because banks do not lend to each other (for fear of default by the other party). It is a last resort when simply lowering your interest rate does not seem to produce the desired results. This was the Fed's weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis of 2008. This involves the Fed printing more dollars and using it to buy U.S. Treasuries, primarily from financial institutions. QE usually leads to a weaker US dollar.
Quantitative tightening (QT) is the opposite process in which the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal of maturing bonds in new purchases. Usually positive for the US dollar.
