• USD/CAD advances ahead of Fed and BoC rate decisions, supported by general market caution.
• Markets price in an 89.5% chance of an October Fed rate pause, with potential hikes delayed until December.
• Falling crude prices, triggered by Middle East diplomatic talks, further pressure the commodity-linked Canadian Dollar.

USD/CAD gains ground for the second successive day, trading around 1.4020 during Asian hours on Tuesday. The pair rises as the US Dollar (USD) continues to gain ground, driven by market caution ahead of interest rate decisions by the US Federal Reserve (Fed) and the Bank of Canada (BoC) due Wednesday.

Financial markets expect the Federal Reserve to keep interest rates unchanged at its upcoming October meeting before potentially hiking rates again in December. According to the CME FedWatch Tool, market pricing currently reflects an 89.5% probability of a rate pause at the October policy meeting, alongside an 82.3% chance of a rate increase in December.

Heather Long, chief economist at Navy Federal Credit Union, said that “Inflation is still the No. 1 problem in the US economy, and there are a lot of signs it is getting more broad-based.” “For consumers, it means really high borrowing costs for the foreseeable future.” However, “given that it’s right before an election,” Heather added, “they won’t hike in October.”

The USD/CAD pair gains support as the commodity-linked Canadian Dollar (CAD) faces challenges amid a decline in oil prices. Crude oil prices fell as renewed diplomatic efforts in the Middle East raised hopes of preventing a wider escalation of the US-Iran conflict.

Following high-level talks held in Tehran, Iran, Saudi Arabia, Pakistan, and Turkey agreed on Monday to continue security discussions and enhance regional cooperation, according to Islamic Republic of Iran Broadcasting (IRIB). A joint statement released after the first meeting between Iran and senior officials representing the Mecca Joint Defence Agreement stated that the four countries had agreed to maintain dialogue and consultations, particularly concerning regional peace, security, and stability.

Canadian Prime Minister Mark Carney said on Monday that the country has not changed its position in trade talks with the United States (US). Carney added that any progress made is because Washington moved closer to Canada’s position.

BoC hike risk rises as markets price in four moves by 2027

Analysts at Commerzbank highlight that Governor Tiff Macklem’s recent communication has materially shifted the policy outlook, noting that “Macklem’s latest comments have significantly increased the risk of an imminent rate hike, and we therefore expect an initial move before the end of this year.” They point out that “market participants assign an 85% probability to a rate hike this week, and we also expect a hike given the recent more hawkish comments,” but caution that “we nevertheless consider such a move due to the subdued core inflation premature.” Looking further ahead, Commerzbank observes that “a total of four rate hikes are priced in by September 2027,” underscoring how aggressively markets have adjusted their expectations for the BoC policy path.

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.

Akhtar Faruqui is a Forex Analyst based in New Delhi, India. With a keen eye for market trends and a passion for dissecting complex financial dynamics, he is dedicated to delivering accurate and insightful Forex news and analysis.