Oil Surge and Fed Rate Outlook Weigh on USD/CAD as Middle East Crisis Escalates

The USD/CAD exchange rate has retreated toward the 1.3650 level during early Monday trading, marking its second consecutive session of weakness. The pair remains under pressure near its five-month bottom of 1.3642, established on December 26, as geopolitical tensions in the Middle East provide tailwinds to crude prices, benefiting the commodity-sensitive Canadian Dollar.

Energy Markets Drive Currency Movements

Rising oil prices are the primary catalyst supporting CAD strength. West Texas Intermediate crude is trading near $57.20, recovering from a 2.5% decline in the prior session, as escalating Middle East conflicts—including Saudi military operations in Yemen and Iran’s escalatory rhetoric—intensify supply disruption fears. Given Canada’s role as the leading crude supplier to the United States, higher petroleum valuations translate directly into CAD appreciation. This dynamic reveals why tracking USD/CAD movements at levels near 1.3650 remains critical for traders monitoring commodity-currency correlations.

US Dollar Pressured by Rate Cut Expectations

Simultaneously, the US Dollar faces headwinds from evolving Federal Reserve monetary policy expectations. Market participants are increasingly pricing in the possibility of two additional rate cuts during 2026, weighing on USD demand. The Fed previously reduced rates by 25 basis points in December, bringing the policy range to 3.50%–3.75%. Throughout 2025, the central bank delivered a cumulative 75 basis points in cuts as labor market softness and persistent inflation concerns drove the easing cycle.

Recent CME FedWatch data illustrates shifting rate expectations: the probability of rates remaining unchanged at January’s meeting stands at 81.7%, up from 77.9% one week prior. Conversely, the odds of a 25-basis-point reduction have diminished to 18.3% from 22.1%. Traders will scrutinize Tuesday’s FOMC December meeting minutes for insights into committee members’ policy deliberations and 2026 guidance.

Canadian Dollar Dynamics: A Multifactor Framework

The Canadian Dollar’s valuation hinges on several interconnected variables. Beyond oil prices, interest rate differentials—particularly decisions by the Bank of Canada—significantly influence CAD direction. Higher BoC rates typically strengthen the currency by attracting investment capital. Economic indicators including GDP growth, employment figures, and trade balances also shape CAD performance. Meanwhile, US economic health and risk sentiment continue exerting influence, given America’s status as Canada’s predominant trading partner. The interplay of these factors determines whether USD/CAD continues consolidating near current levels or tests new technical support levels.