During the Asian trading session on Thursday, the USD/CAD pair retreated to around 1.4160, potentially marking its third consecutive day of losses.

The Canadian dollar is drawing support from a combination of two key factors. Firstly, escalating tensions between the US and Iran have triggered a significant surge in crude oil prices, benefiting the currency of Canada, a major oil exporter. Secondly, market expectations for a Bank of Canada interest rate hike this year have intensified markedly, with the perceived probability jumping from 40% to approximately 60% within just two days.

In a recent report, strategists Sean Osborne and Eric Theoret from Scotiabank noted, "The CAD has held up relatively well in overnight moves. Negative CAD sentiment is abating, but spot rates are still at quite high levels." This assessment accurately captures the current push-and-pull dynamics for the loonie: while supportive factors are building, a full reversal from its previously established weak trend is not yet complete.

Geopolitical Catalyst: US-Iran Tensions Fuel Oil Supply Fears

Geopolitical tensions escalated further on Thursday. Media reports indicated that US forces used cruise missiles to strike a railway line in Iran's northeastern Golestan province near the border. This marks the first US attack on Iranian infrastructure since a ceasefire agreement took effect. Iran reported that several US projectiles hit a railway bridge west of Aghala in Golestan province, causing multiple explosions.

This latest military escalation follows former President Trump's announcement on Wednesday that a temporary US-Iran agreement "has ended." Iran's Parliament Speaker, Mohammad Bagher Ghalibaf, warned Washington that any US military action would be met with retaliation.

For the Canadian dollar, the transmission channel from this conflict is direct. As a major petroleum exporter, Canada's currency typically receives a boost from rising crude oil prices driven by tensions in the Strait of Hormuz. West Texas Intermediate crude, after surging over 3% previously, maintained its strength, providing ongoing support for the loonie.

Central Bank Policy: Rate Hike Expectations Surge

Beyond oil prices, shifting monetary policy expectations are providing additional upward momentum for the Canadian dollar. The Bank of Canada held its benchmark overnight rate steady at 2.25% at its June policy meeting, marking the fifth consecutive pause. However, market pricing for the central bank's future policy path is undergoing a significant shift.

Market data shows traders now see about a 60% chance of a Bank of Canada rate hike this year, a sharp 20-percentage-point increase from the 40% probability seen on Tuesday. This rise in expectations is occurring against a backdrop of renewed Fed rate hike bets due to inflation concerns, suggesting the anticipated policy divergence between the Bank of Canada and the Federal Reserve is narrowing. If the Canadian central bank does need to follow with rate hikes to curb inflationary pressures, the loonie's interest rate differential advantage would be reinforced.

Analyst Assessment: Sentiment Improves, But Valuation Remains High

The evaluation from Scotiabank strategists offers a professional third-party perspective. They view the Canadian dollar as having "held up relatively well" during overnight volatility, with negative sentiment "abating." This suggests the market's outlook for the loonie is gradually recovering from excessive pessimism.

However, they also cautiously note that "spot rates are still at quite high levels." This implies that while USD/CAD has retreated from recent highs, the current exchange rate remains elevated, and a sustained further strengthening of the Canadian dollar would require confirmation from additional positive factors.

This Scotiabank assessment echoes the market's increased pricing for a Bank of Canada hike but also hints that the loonie's near-term upside path may not be entirely smooth.

Market Outlook: Dual Support in Place, But More Catalysts Needed

In summary, the Canadian dollar is currently underpinned by the dual tailwinds of strong oil prices and rising domestic rate hike expectations. The ongoing escalation in US-Iran tensions provides a persistent positive driver via the energy price channel, while the market's repricing of the Bank of Canada's policy path bolsters the loonie's appeal from an interest rate differential perspective.

Nevertheless, the potential for further Canadian dollar strength remains uncertain. Geopolitical factors are highly unpredictable—a de-escalation in Middle East tensions and a subsequent retreat in oil prices would weaken a key pillar of support. Furthermore, the performance of Canada's own economic data will influence the sustainability of market rate hike expectations.

In the short term, USD/CAD may test key support zones around 1.4150 or even 1.4100. However, in the absence of additional catalysts, the potential for further downside could be limited. Traders are awaiting the latest US initial jobless claims data, due Thursday, which will impact the broader US dollar and indirectly influence the USD/CAD pair.

As of 13:20 Beijing Time, the USD/CAD pair was quoted at 1.4161/62.