Canadian Dollar Strengthens Against US Dollar as Oil Rally Gains Momentum from Middle East Geopolitical Risks

The USD/CAD exchange rate is currently trading in the 1.3650-1.3660 range, marking a second consecutive day of weakness for the American currency. The pair continues to hover near its five-month trough of 1.3642, recorded on December 26, as geopolitical tensions in the Middle East propel crude prices higher.

Oil Prices Drive CAD Appreciation Amid Regional Instability

Energy Market Dynamics

West Texas Intermediate crude is bouncing back decisively, trading around $57.20 after experiencing a sharp 2.5% decline in the previous trading session. The rebound stems from escalating Middle East concerns, including Saudi military operations in Yemen and Iran’s declaration of “full-scale war” against Western nations and Israel. These developments amplify worries about potential supply disruptions in a region critical to global energy markets.

For traders monitoring the USD to CAD conversion, understanding oil’s role is essential. Since petroleum represents Canada’s largest export commodity, rising crude prices directly strengthen the Canadian currency. A 28 USD to CAD scenario becomes more favorable for Canadian exporters when energy markets rally, creating natural support for the loonie.

Interest Rate Divergence Weakens the US Dollar

The Fed’s recent decision to lower rates by 25 basis points has left the door open for additional monetary easing. Market expectations now point to potentially two more rate cuts throughout 2026, reducing the appeal of USD-denominated assets. The CME FedWatch tool reflects this sentiment, showing an 81.7% probability that the Fed will maintain its current 3.50%-3.75% target range at the January meeting.

This policy outlook contrasts sharply with the uncertainty surrounding future moves. A week ago, market participants priced in a 22.1% chance of a 25-basis-point cut at the next decision; that probability has since fallen to 18.3%. Such shifts in rate expectations typically weaken the dollar and support commodity-linked currencies like the Canadian dollar.

Upcoming FOMC Minutes May Clarify Policy Direction

Traders should mark Tuesday’s calendar for the release of December FOMC meeting minutes. These discussions often reveal the reasoning behind rate decisions and provide insight into how Fed officials view 2026’s economic trajectory. Given the labor market’s recent cooling and persistent inflation concerns, the committee’s language could significantly influence currency pairs and broader risk sentiment.

The Fed’s cumulative 75 basis points of cuts in 2025 reflects a gradual shift toward accommodation. However, the recent pullback in rate-cut expectations suggests central bankers may be taking a more cautious approach as data evolves.

What Drives Canadian Dollar Movement Beyond Oil

While energy prices dominate CAD valuations, multiple factors collectively influence the currency’s direction. Bank of Canada policy, trade balance dynamics, and broader economic health all play supporting roles. A strong domestic economy typically attracts foreign investment and could prompt the BoC to maintain or raise rates—both bullish signals for the loonie.

Conversely, weak economic data or deteriorating trade balances can quickly reverse currency gains. Inflation trends also matter; while elevated inflation traditionally weakened currencies, modern interest rate responses often produce the opposite effect by drawing capital inflows.

As the USD to CAD exchange rate continues oscillating near current levels, watching both crude prices and Fed policy communications remains crucial for positioning in this key currency pair.