One-month highs for Canadian Dollar as BoC rate-hike expectations build

• USD/CAD falls further on BoC rate-hike expectations and US Dollar weakness.
• Oil gains and easing political uncertainty in Alberta provide further backing for the Loonie.
• Lower US Treasury yields pressure the Greenback, but hawkish Fed expectations contain the downside.

USD/CAD trades around 1.4052, close to one-month lows, at the time of writing. The pair continues its run of losses on Tuesday, with the Canadian Dollar (CAD) supported by US Dollar (USD) weakness and mounting expectations of a Bank of Canada (BoC) interest rate increase. Traders are also weighing conflicting reports on diplomatic efforts in the Middle East.

A proposal put to senior Iranian officials by Pakistan’s army chief has secured American approval and preliminary agreement from Iran, according to Israel’s Channel 12 News. The report initially sent Oil prices lower. They swiftly recovered, however, after Bloomberg cited a diplomat involved in US-Iran negotiations who challenged claims that an agreement was near, without denying that discussions remained under way.

Canada’s position as a major crude exporter means rising Oil prices also provide some support for its commodity-linked currency. Separately, the rejection of separation from Canada by Alberta, the country’s major Oil-producing province, has removed a source of political uncertainty.

A shift towards more hawkish expectations for Bank of Canada (BoC) interest rates is providing further support for the currency. The bank is now widely expected by traders to make its first rate increase of the year at the October 28 meeting. Over the weekend, Governor Tiff Macklem said sustained high energy prices would prompt the central bank to raise its inflation forecasts significantly in the forthcoming quarterly projections.

Higher petrol prices lifted Canada’s annual inflation rate to 3.1% in September, according to data published on Monday. Although that marked a four-month high, the figure fell short of the market’s 3.2% forecast.

Canadian bond yields have risen as expectations of a BoC rate increase build, reducing the yield gap with US bonds. In recent weeks, higher US yields have been a significant drag on the Canadian Dollar.

The benchmark 10-year US Treasury yield is now near 5.08%, compared with around 5.36% earlier this month. Treasury yields have pulled back from multi-year highs, putting pressure on the US Dollar, after concerns about AI-related investments drove investors towards government bonds last week.

The prospect of another Federal Reserve (Fed) interest rate increase before year-end could nevertheless limit declines in both the Greenback and Treasury yields. September’s stronger-than-expected US inflation reports strengthen the argument for additional tightening as policymakers work to return inflation towards the central bank’s 2% target.

Despite those expectations, traders anticipate no rate change at the Fed’s October 27-28 meeting, after September’s increase of 25 basis points (bps). According to the CME FedWatch Tool, markets assign a 17% probability to a rate rise this month and a 92% probability to an increase in December.