If U.S. interest rates rise, what typically happens to the USD/CAD exchange rate?

• A. The U.S. dollar strengthens against the Canadian dollar
• B. The Canadian dollar strengthens against the U.S. dollar
• C. There is no impact on USD/CAD
• D. Both currencies weaken

Answer: (A)

When U.S. rates rise, the yield differential between the United States and Canada widens in favor of the U.S. This makes U.S. assets more attractive to investors, attracting capital into dollars. As demand for USD increases relative to CAD, the U.S. dollar strengthens, so the USD/CAD rate moves higher (more Canadian dollars needed to buy one U.S. dollar). In other words, higher U.S. rates typically push the USD up against the CAD. Keep in mind that expectations matter: if the rise is anticipated, some of the move may be priced in, but the directional effect remains that the dollar strengthens against the Canadian dollar.