USD/CAD: Loonie Loses Steam as Fed Tightening Looms

The Canadian dollar weakened against its U.S. counterpart on Tuesday amid fears the Federal Reserve will become more hawkish on inflation tomorrow, thus strengthening the greenback.

Today, the USD/CAD rose to 1.2417 up from Monday’s close of 1.2367. Still, the Canadian dollar gained about 2.3% last month after depreciating around 0.5% in September.

Investors have become concerned the Fed may withdraw its economic support due to slow global growth and high inflation, which will push the greenback further up. 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 on Wednesday.

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 dollar index, which measures the value of the dollar against six foreign currencies, was trading 0.06% higher at 94.073.

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 as pressure grows ahead of OPEC+ meeting, where they are expected to maintain production cuts. At the time of writing, U.S. West Texas Intermediate (WTI) crude was trading 0.74% lower at $83.44 a barrel. Lower oil prices lead to lower U.S. dollar earnings for Canadian exporters, resulting in a decreased value of the loonie.

“The October BoC meeting was the hawkish surprise. The BoC ended QE and entered the reinvestment phase at this meeting. Our base case is now for the first-rate hike at the April 2022 meeting. We continue to think subsequent rate hikes may be gradual, proceeding quarterly in July and October as the BoC may be cognizant of not moving too far ahead of the Fed,” noted analysts at Citi.

“USDCAD already had and continues to have a very clear head and shoulders top which suggests a move towards 1.20 can be seen. If USDCAD closes below 1.2350, it may complete a bearish outside day.”