Canadian Dollar languishes near 0.8200 as Fed tightening bets buoy US Dollar

USD/CAD rally halted below monthly highs at 1.3940, but downside attempts remain limited above 1.3900 so far.
Rising hopes that the Fed will hike rates on Wednesday keep the US Dollar buoyed against its main peers.
Higher Crude prices are providing some support to the commodity-sensitive Loonie.

Guillermo Alcala FXStreet

The Canadian Dollar (CAD) hovers near monthly lows against the US Dollar (USD) on Tuesday, as rising expectations that the Federal Reserve (Fed) will tighten its monetary policy on Wednesday underpin speculative demand for the Greenback. The USD/CAD consolidates gains at the 1.3900 area, after having rallied continuously during the last four days.

Markets are focusing on the two-day Federal Open Market Committee (FOMC) meeting, starting on Tuesday and expected to deliver the first interest rate hike in the last three years.

Futures markets are pricing a 92% chance of a 25 basis point hike on Wednesday, according to data from the CME’s Fed Watch Tool. A strong employment report in August and the hot inflation figures released on Tuesday have boosted expectations of some Fed tightening on Wednesday and another one before the year-end, probably in December.

High Crude prices support the Canadian Dollar

The Canadian Dollar, on the other hand, is drawing some support from the elevated Oil prices. Brent Oil trades at $104.35 at the time of writing, highlighting a 22% appreciation from late-August lows, while the US Benchmark WTI trades a few cents below $100. Oil is Canada's main export, and higher prices tend to have a positive impact on the Loonie.

The Oil rally has offset soft Canadian macroeconomic data seen on Monday. August Consumer Price Index (CPI) contracted by 0.1%, below the 0% market consensus, following a 0.5% rise in July. Yearly inflation, however, kept growing at a steady 3% pace, in line with market expectations. Beyond that, Manufacturing Sales contracted by 0.4%, beyond the expected 0.2% decline, adding negative pressure on the CAD.

These figures provide some leeway for the Bank of Canada (BoC) to keep interest rates on hold in the coming months, aiming to support economic growth in an uncertain context amid the trade war with its southern neighbour. This is leading to a monetary policy divergence that is undermining speculative support for the Canadian Dollar.

Interest rates FAQs

What are interest rates?

Interest rates are charged by financial institutions on loans to borrowers and are paid as interest to savers and depositors. They are influenced by base lending rates, which are set by central banks in response to changes in the economy. Central banks normally have a mandate to ensure price stability, which in most cases means targeting a core inflation rate of around 2%. If inflation falls below target the central bank may cut base lending rates, with a view to stimulating lending and boosting the economy. If inflation rises substantially above 2% it normally results in the central bank raising base lending rates in an attempt to lower inflation.

How do interest rates impact currencies?

Higher interest rates generally help strengthen a country’s currency as they make it a more attractive place for global investors to park their money.

How do interest rates influence the price of Gold?

Higher interest rates overall weigh on the price of Gold because they increase the opportunity cost of holding Gold instead of investing in an interest-bearing asset or placing cash in the bank. If interest rates are high that usually pushes up the price of the US Dollar (USD), and since Gold is priced in Dollars, this has the effect of lowering the price of Gold.

What is the Fed Funds rate?

The Fed funds rate is the overnight rate at which US banks lend to each other. It is the oft-quoted headline rate set by the Federal Reserve at its FOMC meetings. It is set as a range, for example 4.75%-5.00%, though the upper limit (in that case 5.00%) is the quoted figure. Market expectations for future Fed funds rate are tracked by the CME FedWatch tool, which shapes how many financial markets behave in anticipation of future Federal Reserve monetary policy decisions.

Author

Guillermo Alcala

FXStreet

Graduated in Communication Sciences at the Universidad del Pais Vasco and Universiteit van Amsterdam, Guillermo has been working as financial news editor and copywriter in diverse Forex-related firms, like FXStreet and Kantox.

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