During Monday's Asian session, the USD/CAD pair edged lower to trade near 1.4080, reversing a slight gain from the previous trading day.

Over the weekend, military hostilities between the US and Iran were paused. After 13 consecutive days of escalating conflict, the US halted its strikes, and Iran suspended its retaliatory actions. This phase of easing geopolitical tensions weakened the safe-haven appeal of the US dollar, pushing markets into a risk-on mode.

However, the Canadian dollar's upward momentum is significantly constrained by a sharp drop in oil prices. While shipping restrictions in the Strait of Hormuz and the Red Sea remain in place, the ceasefire itself has been sufficient for the market to reprice the extreme geopolitical risk premium that had been factored in.

Ceasefire Reshapes Market Risk Appetite

Last weekend, the US paused its bombing campaign after 13 nights of airstrikes on targets in Iran, and Tehran subsequently suspended its retaliatory attacks on Washington's Middle Eastern allies. This opening of a "diplomatic window" has fueled market expectations that the five-month-long conflict might be approaching a turning point.

The market's reaction has been a classic "return to risk appetite" pattern: safe-haven assets (the US dollar) are being sold off, while risk assets (commodity currencies like the Canadian dollar) are attracting buyers. The safe-haven capital that had previously flowed into the dollar due to the escalating Middle East conflict is now starting to reverse.

Nevertheless, concerns over supply disruptions have not completely dissipated. The Houthi group has claimed responsibility for attacks on Saudi facilities along the Red Sea coast, indicating that the conflict is not fully resolved, but has merely shifted from direct US-Iran confrontation to a persistent proxy-level friction.

The underlying reasons for the US pause in strikes are also noteworthy. Reports suggest that dwindling interceptor inventories and a shortage of viable targets within Iran were key constraints.

Chairman of the Joint Chiefs of Staff, General C.Q. Brown, reportedly warned President Trump that continuing the current pace of strikes would severely deplete critical ammunition reserves. This implies the ceasefire could be a passive choice dictated by military resource constraints, rather than a move driven purely by diplomatic goodwill.

Oil Price Plunge Creates a "Double-Edged Sword" for the Canadian Dollar

The expectation of a US-Iran ceasefire has triggered a sharp pullback in crude oil prices, creating a "double-edged sword" effect for the USD/CAD pair.

Through the US Dollar Channel (Positive for CAD): Falling oil prices ease global inflation concerns, weakening expectations for Fed rate hikes, which in turn pressures the US dollar. This is the core logic behind the USD/CAD weakness on Monday.

Through the Commodity Currency Channel (Negative for CAD): As a major oil exporter, lower oil prices imply a deterioration in Canada's terms of trade, undermining the fundamental support for the Canadian dollar. This is the key factor limiting the CAD's gains.

The combined effect of these two forces is that the USD/CAD's decline is relatively limited. As long as oil prices remain above $80 per barrel, the Canadian dollar's commodity currency attribute will still provide some support. However, if oil prices fall further below $80, the CAD could face more significant downward pressure.

Market Cautious Ahead of FOMC Meeting

Beyond the dual narratives of the US-Iran ceasefire and the oil price crash, market attention is turning to Wednesday's FOMC meeting. The consensus is that the Fed will hold interest rates steady. However, TD Securities notes that the Middle East conflict, which has pushed up oil prices, has "increased inflation risks, reinforcing the case for rate hikes."

TD expects two committee members to dissent. This sign of division could undermine the credibility of the "hold steady" policy stance. If the statement's language leans hawkish, the US dollar could quickly recover its losses, pushing USD/CAD back above 1.4150. For USD/CAD, the current policy environment is at a delicate balance point: if the Fed holds steady but sends a hawkish signal, the dollar will gain support; if the statement is dovish, the dollar could weaken further.

USD/CAD is currently trading near 1.4080, in the lower-to-mid range of its recent trading band.

Support below: The 1.4030-1.4050 zone is the first support area (near last week's low). A break below this level targets the psychological 1.4000 handle.

Resistance above: The 1.4120-1.4150 zone is the first resistance area (near the 20-day moving average). A break above this level targets the 1.4200-1.4220 range.

Key variables: Progress in US-Iran diplomacy (if talks break down, the dollar will regain safe-haven bids); the FOMC statement's language (the degree of hawkishness will determine the dollar's short-term direction); and oil price trends (a sustained decline will pressure the Canadian dollar through the commodity currency channel).

Institutional Views

In its latest foreign exchange outlook from July 23, Scotiabank maintained its medium-term bullish stance on the Canadian dollar, revising its USD/CAD forecast targets lower to 1.37 for Q4 2026 and 1.33 for Q4 2027, with the overall path pointing downwards. The core logic is that the US-Canada policy rate differential will narrow significantly. The bank expects the Fed to cut rates by about 50 basis points in the first half of 2027, while the Bank of Canada could hike rates by a cumulative 75 basis points to 3.00% over the forecast period.

After falling about 2% against the US dollar in the second quarter, the Canadian dollar has shown tentative signs of a rebound in the third quarter. Scotiabank now assesses that the fair value of the CAD is close to its spot level, suggesting that future moves will be more driven by fundamental factors rather than valuation adjustments. Market sentiment and positioning remain heavily skewed towards bearishness on the Canadian dollar. This structure itself is a potential support for the CAD—once sentiment reverses, the CAD could see a more significant rally.

Canadian Dollar Seeks Balance Between Oil and Safe-Haven Demand

USD/CAD is currently caught in a tug-of-war between bullish and bearish forces. The risk-on mood from the US-Iran ceasefire provides support for the Canadian dollar, but the sharp drop in oil prices limits its upside. The dollar's safe-haven appeal has temporarily faded due to the diplomatic opening, but the FOMC meeting is imminent, and any hawkish signal could trigger a rapid dollar rebound. In the short term, USD/CAD is likely to consolidate within the 1.4000-1.4200 range. For traders, Wednesday's FOMC meeting is the real highlight of the week. Directional bets should be cautious until then. Whether the Canadian dollar can continue to strengthen against the headwind of falling oil prices depends on whether the Middle East situation can maintain its easing trend and whether the Fed's policy signals are dovish enough.