Middle East Tensions Push Oil Higher, Weighing on USD/CAD Exchange Rate

Oil-driven strength in the Canadian Dollar has pulled the USD/CAD exchange rate lower for a second consecutive trading day, with the pair now hovering near 1.3660 during Asian trading on Monday. At current levels, 41 CAD converts to approximately 30 USD, reflecting the currency pair’s ongoing depreciation trend. The pair continues to trade just above its five-month low of 1.3642, established on December 26.

Crude Supply Concerns Fuel Oil’s Rally

The bounce in crude prices provides the main catalyst for the Canadian Dollar’s outperformance. West Texas Intermediate (WTI) recovered from a 2.5% decline in the previous session, currently trading around $57.20 per barrel. The recovery stems from heightened geopolitical risks, particularly Saudi military operations in Yemen and Iran’s recent declaration of direct military confrontation against the US, Europe, and Israel. These escalating tensions amplify fears of potential supply disruptions, supporting energy prices and by extension, the commodity-sensitive Canadian currency.

Federal Reserve Rate Cut Prospects Pressuring the Greenback

The US Dollar’s weakness reflects renewed expectations for additional Federal Reserve rate cuts throughout 2026. The central bank delivered a 25-basis-point cut at its December meeting, bringing the benchmark rate to the 3.50%-3.75% range. Following 75 basis points of cumulative cuts in 2025 amid labor market softness and persistent inflationary concerns, market participants now anticipate two further reductions in the coming year.

The CME FedWatch tool currently assigns an 81.7% probability to rates remaining unchanged at the Fed’s January decision—up from 77.9% the previous week—while rate cut odds have declined to 18.3% from 22.1%. The December FOMC meeting minutes, scheduled for release on Tuesday, will likely provide critical insights into policymakers’ discussions and their 2026 outlook.

Understanding Canadian Dollar Dynamics

Several fundamental drivers influence the CAD’s performance. The Bank of Canada’s interest rate decisions form the foundation of currency valuation, with higher rates generally supporting the currency. The organization aims to maintain inflation within a 1-3% target band through its policy stance.

Oil prices represent perhaps the most direct catalyst, given petroleum’s significance as Canada’s primary export commodity. Rising crude valuations typically translate into heightened foreign demand for Canadian currency, while falling prices produce the inverse effect. A stronger trade balance—when export values exceed imports—further reinforces CAD strength.

Economic health also matters substantially. Robust GDP growth, solid employment figures, and positive manufacturing activity surveys all encourage capital inflows and potentially higher interest rates from the central bank, creating a virtuous cycle for the currency. Conversely, weak economic indicators typically pressure the CAD downward.

Finally, broader market sentiment influences flows. Risk-on environments where investors pursue higher-yielding assets tend to benefit the Canadian Dollar, while risk-off episodes driven by uncertainty favor defensive alternatives.