USD/CAD recovers earlier losses after US PMI data beats expectations

• USD/CAD recovers from early weakness on Thursday after the release of US PMI data beats estimates in May. 
• The Services PMI beat which may be critical to interest-rate expectations given the sector was singled out as an inflation hotspot by the Fed.
• The Bank of Canada is expected to cut interest rates in either June or July – the Fed not till September at the earliest. 

USD/CAD is trading in the 1.3680s at the time of writing after a sharp rise following the release of preliminary US Purchasing Manager Index (PMI) data for both the Services and Manufacturing sector. The PMI survey data showed a higher-than-expected reading in May, indicating an expansion of economic activity that bodes well for the US Dollar (USD) and gives USD/CAD an extra boost. 

US S&P Global Manufacturing PMI came out at 50.9 in May, up from the 50.0 in April and the 50.0 forecast by economists. Services PMI, meanwhile, rose to 54.8 from 51.3 in the previous month and 51.3 forecast. Composite PMI came out at 54.4 in May, up from 51.3 in April – and beating the decline to 51.1 economists had expected. 

The higher-than-expected Services PMI data, in particular, will have supported the US Dollar (USD) as the Federal Reserve (Fed) has highlighted Services-sector inflation as a key hotspot in the economy that needs to cool down before it moves to cut interest rates. The maintenance of higher interest rates supports the USD since it attracts higher inflows of foreign capital compared to lower interest rates. 

USD/CAD had been trading significantly down for the day prior to the data on the back of a mixture of higher Crude Oil prices (CAD positive), positive risk appetite (CAD positive), better-than-expected Canadian Housing data and technical chart resistance. Following the data, however, it made up a substantial portion of its earlier losses.  

The Canadian Dollar (CAD) is likely to see limited upside against the US Dollar (USD) putting a floor under downside for the pair, as interest rate differentials, a key FX driver, remain favorable for USD. Recent Canadian inflation data for the month of April showed price pressures cooling in line with analysts’ estimates. The data brought the date when the Bank of Canada (BoC) is likely to cut interest rates closer. The money markets are pricing in a 53% chance of a 25 basis point (bps) cut in June, while the possibility of a July rate cut is fully priced in.

The US Federal Reserve (Fed) in contrast keeps delaying an expected cut in interest rates. Most recently, the Minutes from the Fed’s April-May meeting revealed that policymakers thought interest rates should remain at their current level “at least until September,” and even discussed the possibility that they might need to be increased. A key determining factor for the course of future policy would be the evolution of the labor market, they added.