USD/CAD flirts with 1.2500 amid bullish oil prices, stronger USD helped limit losses

• Bullish oil prices underpinned the loonie and kept USD/CAD on the defensive on Tuesday.
• Surging US bond yields acted as a tailwind for the USD and extended support to the major.
• The mixed fundamental backdrop warrants some caution before placing directional bets.

The USD/CAD pair remained on the defensive through the early European session and was last seen trading around the key 1.2500 psychological mark.

The pair added to the overnight modest losses and edged lower for the second successive day on Tuesday amid bullish crude oil prices, which tend to underpin the commodity-linked loonie. In fact, the black gold rallied to a more than seven-year high in the wake of rising geopolitical tensions in the Middle East.

In fact, Yemen's Houthi group claimed to have launched a drone strike on the United Arab Emirates’ capital city of Abu Dhabi, killing three people. This fueled worries about possible supply disruptions from the third-biggest OPEC producer and added to the bullish sentiment amid shrinking global oil inventories.

The downside, however, remains cushioned, at least for now, on the back of a broad-based US dollar strength, bolstered by surging US Treasury bond yields. The yield on the benchmark 10-year US government bond shot to the highest level since January 2022 amid bets that the Fed would start raising rates in March 2022.

The mixed fundamental backdrop warrants some caution before positioning for any firm near-term direction ahead of the upcoming FOMC policy meeting on January 25-26. In the meantime, traders on Tuesday will take cues from the release of the Empire State Manufacturing Index and oil price dynamics for some short-term opportunities.

Technical levels to watch