USD/CAD: Loonie Falls on Weak Q3 GDP; Fed Decision Eyed Next Week

The Canadian dollar depreciated against its U.S. counterpart in early trade Friday on weaker than expected third quarter GDP and fears the Federal Reserve will become more hawkish on inflation weighed on the commodity currency.

“The CAD is liable to soften towards 1.25 and might extend towards 1.26 if the Bank sticks with the view that the output gap will not close until later in 2022. Governor Macklem may try to finesse that point a little in the press conference but will not want to get too tied down on the precise timing of rate hikes,” noted Shaun Osborne, Chief FX Strategist at Scotiabank.

“In the unlikely event of the bank sounding more hawkish and effectively endorsing current market pricing for rates, the CAD will rally towards the low 1.23s at least.”

Today, the USD/CAD rose to 1.2394 up from Thursday’s close of 1.2342. Still, the Canadian dollar gained about 2.4% so far this month after depreciating around 0.5% in September.

A flash estimate said that third-quarter annualized GDP increased by just 1.9%, much less than the Bank of Canada’s forecast of 5.5%.

On Wednesday, the Bank of Canada surprised markets by announcing the end of Quantitative Easing and revised its outlook for overnight rates, signalling that slack will be fully absorbed by the middle of next year rather than previous expectations of the second half of next year.

The dollar index, which measures the value of the dollar against six foreign currencies, was trading 0.40% higher at 93.717. The U.S. dollar has gained across most currencies in the last few weeks as investors have become concerned the Fed may withdraw its economic support due to slow global growth and high inflation.

The Investors are already looking past the months-long process of scaling back the Fed’s $120 billion in monthly bond purchases, which is expected to be announced next week in its November meeting. They are more concerned with when interest rates will be raised by the central bank and have shifted forward their expectations for the first hike because of high inflation readings.

“The US economy continues to face upward pressure on inflation with some initial signs emerging of wage-price 2nd round effects. But Fed speak seems to be pushing back on earlier rates. This combination should be negative for USD and DXY has responded accordingly,” noted analysts at Citi.

“At the same time, USD is also facing pressure from the more aggressive rates liftoff pricing evident in many other G10 rates curves (NZD, CAD, GBP, AUD in particular) where scope for central bank pushback remains relatively limited. Nevertheless, DXY still remains within the 93.44 – 94.65/79 range with support coming from (still) lingering US debt ceiling concerns.”

Investors were concerned that increasing inflationary pressures could pose a headwind to the economy and affect how soon the Federal Reserve may be able to raise rates. Rising bond yields have contributed to the strengthening of the currency.

It is highly likely that the world’s dominant reserve currency, the USD, will rise by end of the year, largely due to the expectation of at least one rate hike next year. With the dollar strengthening and a possibility that the Federal Reserve will raise interest rates earlier than expected, the USD/CAD pair may experience a rise.

Canada is the world’s fourth-largest exporter of oil, which edged lower on Iran talks and U.S. stocks build. At the time of writing, U.S. West Texas Intermediate (WTI) crude was trading 1.15% lower at $81.87 a barrel. Lower oil prices lead to lower U.S. dollar earnings for Canadian exporters, resulting in a decreased value of the loonie.