Canadian Dollar tests monthly lows against US Dollar ahead of Fed decision

• USD/CAD extends gains for the sixth consecutive day to test monthly highs at 1.3935.
• Markets are pricing a 92% chance of a Fed rate hike on Wednesday and an 80% probability of at least one more before the end of the year.
• Fed-BoC monetary policy divergence is offsetting the positive impact of higher oil prices on the CAD.

The Canadian Dollar (CAD) trades lower against a firm US Dollar (USD) on Wednesday, with the market positioned for a quarter rate hike by the Federal Reserve (Fed), the first one in three years, later in the day. The USD/CAD accumulates a 1% rally on a six-day wim¡ning streak that has brought the pair to test monthly highs at 1.3935 at the time of writing.

Strong US employment and hot inflation figures have triggered a hawkish repricing of the US central bank’s near-term monetary policy that has been boosting the Greenback across the board over the last few days. Futures markets are pricing a 92% chance of a quarter-point rate hike later on Wednesday and a nearly 80% chance of at least another one before the end of the year, up from 60% and less than 50% respectively one week before, according to figures by the CME's FedWatch Tool.

Dollar path hinges on Fed tone as markets eye second hike

Analysts at Societe Generale observe that the US Dollar's near-term direction depends on nuances from Fed Chair Kevin Warsh. If Warsh “does not sound hawkish (and) the market starts doubting there will be a second hike by the end of the year, assuming there is one today (...) the dollar will struggle to make further gains,” says the bank in a note.

Conversely, Societe Generale maintains that “if, however, it appears that we are likely to see a further hike after today, which is our expectation, the dollar has some additional upside from current levels.”

The Canadian Dollar, on the other hand, has failed to draw any significant support from high Oil prices, a traditional support for the Loonie, as Crude Oil is Canada's main export. Brent Crude consolidates gains around $104.00 per barrel, just below the four-month highs above 106.00 hit last week, after rallying more than 20% over the last two weeks, with the conflict in the Middle East sliding into a particularly uncertain phase, as regional powers enter the scene.

Beyond that, monetary policy divergence poses additional pressure on the CAD, as the Bank of Canada (BoC) is widely expected to leave interest rates on hold for the rest of the year, at least. The higher inflationary pressures have triggered some speculation about a rate hike in December, although the BoC seems unlikely to confirm those views unless the trade status with the US improves.