The Canadian Dollar traded without a clear bias against the US Dollar on Monday, leaving USD/CAD oscillating above 1.3950, while the year-to-date peak at 1.4020 remained nearby. A risk-on tone followed news of a memorandum of understanding between the US and Iran to end the three-month war and reopen the Strait of Hormuz, which coincided with the US Dollar registering the weakest performance among major currencies. However, the CAD failed to benefit as declining crude prices weighed on Canada’s terms of trade, with Brent at three-month lows.

Markets also looked ahead to the US Federal Reserve meeting on Wednesday, where policy is expected to be left unchanged, with attention on updated rate and economic projections and Chairman Kevin Warsh’s press conference for any shift in forward guidance. In Canada, the Bank of Canada kept rates steady last week and cited the challenge of high inflation alongside sluggish growth; the CAD slipped past 1.4000 versus the US Dollar for the first time since last November. Central banks typically pursue price stability, often around a 2% inflation target, using policy rates via monetary tightening or easing, set by politically independent boards led by a chair operating under blackout-period rules.

USD/CAD Stuck in Tight Range as Geopolitics and Oil Prices Offset Dollar Weakness

We see the USD/CAD pair in a state of equilibrium, caught between broad US Dollar weakness and the direct negative impact of falling oil prices on the Canadian economy. The pair has been oscillating in a tight range between 1.3920 and 1.3980 as the market digests the recent geopolitical de-escalation. This tug-of-war means that any directional move will likely require a new, powerful catalyst.

The resolution in the Strait of Hormuz has sent Brent crude futures tumbling below $78 a barrel, a drop of over 8% in the past week and the lowest level since March. This directly pressures the CAD, as it will likely translate to lower export revenues and curb Canadian economic growth. The significant decline in Canada’s primary export is neutralizing any benefit the currency might have otherwise gained from the softer US dollar.

Central Bank Divergence and Positioning Ahead of the Fed

We believe the key driver in the coming weeks will be the divergence between central bank outlooks, especially with the Federal Reserve meeting this Wednesday. Canada’s latest GDP reading came in at a weak 0.1% for the month, while year-over-year inflation remains sticky at 3.2%, justifying the Bank of Canada’s cautious stance. The US economy appears more resilient, with core inflation holding at 3.5% and the latest jobs report showing a solid addition of 210,000 payrolls.

Given this backdrop, we anticipate volatility will increase around the Federal Reserve’s announcement. Any hint of a hawkish tone from new Chairman Kevin Warsh, emphasizing the stronger US data, could easily propel USD/CAD through the key 1.4020 resistance level. Derivative markets are already hinting at this possibility, as one-month risk reversals continue to show a moderate premium for USD calls over puts.

Consequently, we see value in using options to position for a potential breakout higher in USD/CAD. Buying call options or call spreads provides a defined-risk way to capitalize on a move above the year-to-date highs. This strategy seems particularly prudent as we await the Fed’s new economic projections, which could confirm the relative strength of the US economy.