Canadian Dollar declines as stronger US Dollar and lower oil prices weigh

• With Fed and BoC rate decisions approaching, broader market caution helps USD/CAD move higher.
• An October Fed pause carries an 89.5% probability in market pricing, with any further rate rises expected to wait until December.
• Diplomatic discussions in the Middle East have pushed crude prices lower, adding to pressure on the commodity-linked Canadian Dollar.

At around 1.4020 during Tuesday’s Asian session, USD/CAD is extending its advance into a second consecutive day. Supporting the pair is continued US Dollar (USD) strength as markets remain cautious before Wednesday’s interest rate decisions from the US Federal Reserve (Fed) and the Bank of Canada (BoC).

An 89.5% probability of unchanged rates at the October policy meeting is currently priced in, according to the CME FedWatch Tool, while the likelihood of a December increase stands at 82.3%. Financial markets therefore anticipate that the Federal Reserve will leave rates on hold at its forthcoming October meeting, with a further rise possible in December.

Commenting on price pressures, Navy Federal Credit Union chief economist Heather Long 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.” She added: “For consumers, it means really high borrowing costs for the foreseeable future.” On the October decision, however, Heather said that “given that it’s right before an election,” adding that “they won’t hike in October.”

Lower oil prices are weighing on the commodity-linked Canadian Dollar (CAD), lending further support to USD/CAD. The decline in crude followed renewed Middle East diplomacy, which fuelled hopes that a broader escalation of the US-Iran conflict could be avoided.

According to Islamic Republic of Iran Broadcasting (IRIB), Iran, Saudi Arabia, Pakistan, and Turkey agreed on Monday to keep security discussions going and strengthen regional cooperation following high-level talks in Tehran. The first meeting between Iran and senior officials representing the Mecca Joint Defence Agreement was followed by a joint statement. It said the four countries had agreed to continue dialogue and consultations, particularly on regional peace, security, and stability.

Canada’s stance in trade negotiations with the United States (US) remains unchanged, Canadian Prime Minister Mark Carney said on Monday. Any progress, Carney added, reflects Washington moving closer to Canada’s position.

Markets price in four BoC hikes by 2027 as near-term risk increases

Governor Tiff Macklem’s recent remarks have substantially altered the policy outlook, according to Commerzbank analysts. They note 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.” On this week’s decision, they say 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,” while warning that “we nevertheless consider such a move due to the subdued core inflation premature.” The scale of the market’s reassessment of the BoC’s policy trajectory is also evident further out: Commerzbank observes that “a total of four rate hikes are priced in by September 2027,” highlighting the aggressive shift in expectations.