USD/CAD remains on the defensive around 1.2700 amid bullish oil prices/weaker USD

• USD/CAD edged lower for the second straight day and was pressured by a combination of factors.
• Bullish oil prices underpinned the loonie and exerted some pressure amid modest USD weakness.
• The Fed’s hawkish stance should lend some support ahead of Canadian GDP and the US ISM PMI.

The USD/CAD pair traded with a mild negative bias heading into the European session and was last seen hovering near the daily low, just below the 0.2700 mark.

The pair witnessed some selling for the second successive day on Tuesday, with bears looking to extend the recent decline from the 1.2800 neighbourhood, or over three-week high set last week. Crude oil prices stood tall near a multi-year high and continued underpinning the commodity-linked loonie. This, along with modest US dollar weakness, exerted some downward pressure on the USD/CAD pair.

The black gold remained supported by expectations that a limited production increase by major oil producers and the post-pandemic recovery in fuel demand will keep a tight supply condition. Apart from this, geopolitical tensions acted as a tailwind for the commodity. Hence, the focus will remain on the OPEC+ decision and development surrounding the conflict between Russia and the West over Ukraine.

On the other hand, the flattening of the US Treasury yield curve kept the USD bulls on the defensive and further contributed to the offered tone surrounding the USD/CAD pair. In fact, the spread between 2 and 10-year US government bonds fell below 60 bps for the first time since early November amid growing acceptance that the Fed will tighten its monetary policy at a faster pace than anticipated.

The markets have fully priced in an eventual liftoff in March and expect five quarter-point rate hikes by the end of 2022. Adding to this, Atlanta Fed President, Raphael Bostic said that the US central bank could raise its benchmark rate by 50 bps if a more aggressive approach to combat high inflation is needed. This dampened future growth prospects, which is playing out in the US bond market.

Nevertheless, the Fed's more hawkish stance supports prospects for the emergence of some USD dip-buying, which should limit the downside for the USD/CAD pair, at least for the time being. Market participants now look forward to the release of the Canadian GDP report and the US ISM Manufacturing PMI. This, along with oil price dynamics, should produce some trading opportunities around the major.

Technical levels to watch