Canadian Dollar retreats as US Dollar benefits from Fed rate hike bets

USD/CAD attracts buyers as hawkish Fed expectations lift the US Dollar.
The BoC is expected to hold its overnight rate at 2.25% on Wednesday.
Fresh tariff measures between Washington and Ottawa keep the Canadian Dollar under pressure.

Vishal Chaturvedi FXStreet

USD/CAD trades on the front foot on Tuesday, supported by a firmer US Dollar (USD), while trade tensions between the United States (US) and Canada and diverging Federal Reserve (Fed) and Bank of Canada (BoC) policy expectations weigh on the Canadian Dollar (CAD). At the time of writing, the pair trades around 1.3881 after rebounding from an intraday low of 1.3845.

The BoC will announce its interest rate decision on Wednesday and is widely expected to leave the overnight rate unchanged at 2.25%, marking a seventh consecutive hold. The latest Canadian data broadly support keeping borrowing costs steady, with underlying inflation close to the central bank’s 2% target and economic activity showing signs of resilience.

In contrast, expectations of a Fed interest rate hike in September are firmly back on the table following Fed Chair Kevin Warsh’s tough stance on inflation, which remains above the central bank’s 2% target. According to the CME FedWatch Tool, traders see around a 65% probability that the Fed will raise borrowing costs at its September 15-16 meeting.

At the same time, energy-driven inflation remains in focus. Elevated Oil prices due to tensions in the Middle East risk intensifying price pressures and forcing major central banks to keep monetary policy restrictive for longer.

The hawkish repricing supports the US Dollar and pushes US Treasury yields higher. The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, trades around 99.59, near the two-week high of 99.72 reached on Friday and retested on Monday. Meanwhile, the benchmark 10-year US Treasury yield rises to around 4.80%, its highest level since January 2025.

Trade tensions resurfaced after the United States imposed 50% tariffs on C$27.6 billion worth of Canadian goods on August 22 following the collapse of bilateral negotiations. Canada responded with matching tariffs on a similar value of US imports, which will take effect on September 8.

Earlier this year, BoC Governor Tiff Macklem warned that “if the United States imposes significant new trade restrictions on Canada, we may need to cut the policy rate further to support economic growth.” Traders will therefore closely examine Wednesday’s policy statement and Macklem’s remarks for clues about how officials assess the latest tariffs.

On the data front, August Manufacturing Purchasing Managers Index (PMI) figures from both sides of the border are due later on Tuesday, followed by US and Canadian employment reports on Friday.

Economic Indicator

BoC Interest Rate Decision

The Bank of Canada (BoC) announces its interest rate decision at the end of its eight scheduled meetings per year. If the BoC believes inflation will be above target (hawkish), it will raise interest rates in order to bring it down. This is bullish for the CAD since higher interest rates attract greater inflows of foreign capital. Likewise, if the BoC sees inflation falling below target (dovish) it will lower interest rates in order to give the Canadian economy a boost in the hope inflation will rise back up. This is bearish for CAD since it detracts from foreign capital flowing into the country.

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