The Canadian Dollar (CAD) weakens against the US Dollar (USD) on Friday, as the Greenback regains some ground after concerns over the Federal Reserve’s (Fed) independence eased somewhat following US President Donald Trump’s decision to nominate a former Fed Governor as the next Fed Chair.
At the time of writing, USD/CAD is trading around 1.3520, up 0.22% on the day, but the pair remains on track for a second consecutive weekly decline.
Concerns over the Fed’s independence were a key driver behind the US Dollar’s recent slide to a four-year low. However, investors have taken some comfort from the prospect of Kevin Warsh, who is widely viewed as a more institutional candidate and likely to preserve the central bank’s independence.
Given Trump’s repeated calls for lower interest rates, markets had feared that his choice for the next Fed Chair could tilt US monetary policy onto a more politically driven and dovish path. While Kevin Warsh has recently aligned himself with Trump’s calls for more aggressive rate cuts, he is traditionally known as an inflation hawk, leading investors to view him as less supportive of deep and rapid interest rate reductions.
That said, broader concerns over the Fed’s independence have not fully faded. Trump has continued to publicly criticise Fed Chair Jerome Powell for not cutting interest rates and has also attempted to remove Fed Governor Lisa Cook, a case that is now before the US Supreme Court. In addition, reports of a recent criminal investigation involving Powell have kept political risk around the central bank in focus.
The US Dollar also finds support from hotter-than-expected Producer Price Index (PPI) data. Headline PPI rose by 0.5% MoM in December, accelerating from 0.2% in November and beating market expectations. On an annual basis, producer prices increased by 3.0%, matching the previous reading and coming in above forecasts of 2.7%.
Core PPI surprised even more to the upside, rising 0.7% MoM in December, well above expectations of 0.2% and the prior 0.0% reading. On a yearly basis, core producer prices climbed to 3.3% from 3.0%, also exceeding market estimates of 2.9%.
The US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, is trading around 96.80, rebounding after hitting a four-year low near 95.56 earlier this week.
On the Canadian side, data showed that the economy stalled in November, with GDP flat on the month after contracting by 0.3% previously and missing expectations for a 0.1% increase, offering little support to the Loonie.
However, rising Oil prices help limit the downside for the Loonie, as Canada is a major crude exporter. WTI is hovering near $65.24 a barrel, its highest level since September 26.
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money.
When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions.
The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.