Canadian Dollar holds gains as US Dollar declines despite increasing Fed rate hike bets
- USD/CAD falls despite hot US CPI data boosts expectations for a Federal Reserve rate hike in late October.
- The Canadian Dollar could weaken as crude oil prices drop on potential US sanction relief for shadow-fleet tankers.
- Proposed US sanction changes aim to lower oil freight costs, outweighing USD weakness to cap USD/CAD downside.
USD/CAD depreciates after registering gains in the previous day, trading around 1.4200 during Asian hours on Thursday. The currency pair lost ground as the US Dollar (USD) struggled while investors continued to evaluate the Federal Reserve’s (Fed) monetary policy outlook in the wake of stronger-than-expected inflation data.
The Bureau of Labor Statistics (BLS) reported on Wednesday that the US Consumer Price Index (CPI)—a broad measure of goods and services costs across the economy—climbed 0.6% month-over-month in September, bringing the 12-month headline rate to 3.7%. Both metrics came in higher than economists' forecasts of 0.6% and 3.6%, respectively. Meanwhile, core CPI (which strips out volatile food and energy components) advanced 0.3% for the month and rose 2.6% on an annual basis, exceeding market estimates of 0.2% and 2.5%.
This hotter-than-anticipated inflation report reinforced expectations for a potentially more hawkish Federal Reserve, bolstering arguments for an interest rate hike at the upcoming Federal Open Market Committee (FOMC) meeting on October 27–28. Following the data release, futures traders raised the probability of a rate hike at the late-October meeting to approximately 31.6%, according to CME Group’s FedWatch tool.
Treasury curve bear flattens as stronger data lifts Fed hike risk
According to TD Securities, the US rates market has responded to the latest data with a pronounced move, as "Treasuries bear flattened sharply as the market penciled in more rate hikes." The firm notes that, despite the repricing of Fed expectations, "we don't expect an October hike despite a sharp increase in pricing," but cautions that "the stronger data hints at the risk of more hikes in the coming months, maintaining upward pressure on rates."
Despite the USD's weakness, downside pressure on the USD/CAD pair could remain limited as the commodity-linked Canadian Dollar (CAD) faces its own headwinds from falling oil prices. Crude prices declined following news that the Trump administration is considering easing sanctions on "shadow fleet" vessels that transport oil and petroleum products from sanctioned nations such as Russia, Iran, and Venezuela.
A US official confirmed Wednesday that the proposed shift is aimed at lowering record-high global freight rates. The policy discussions come shortly after President Donald Trump temporarily lifted sanctions on Russian diesel fuel—a decision that sparked sharp criticism from Ukrainian President Volodymyr Zelenskiy, European allies, and several Senate Republicans.
Canadian Dollar FAQs
The key factors driving the Canadian Dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of Oil, Canada’s largest export, the health of its economy, inflation and the Trade Balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – with risk-on being CAD-positive. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian Dollar.
The Bank of Canada (BoC) has a significant influence on the Canadian Dollar by setting the level of interest rates that banks can lend to one another. This influences the level of interest rates for everyone. The main goal of the BoC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former CAD-negative and the latter CAD-positive.
The price of Oil is a key factor impacting the value of the Canadian Dollar. Petroleum is Canada’s biggest export, so Oil price tends to have an immediate impact on the CAD value. Generally, if Oil price rises CAD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Oil falls. Higher Oil prices also tend to result in a greater likelihood of a positive Trade Balance, which is also supportive of the CAD.
While inflation had always traditionally been thought of as a negative factor for a currency since it lowers the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to lead central banks to put up interest rates which attracts more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in Canada’s case is the Canadian Dollar.
Macroeconomic data releases gauge the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment but it may encourage the Bank of Canada to put up interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.