US CPI bolsters hawkish Fed expectations, putting Canadian Dollar under pressure

• October US inflation figures prompt a US Dollar recovery, lifting USD/CAD.
• An above-forecast US CPI reading leads traders to price in a further Fed rate rise in December.
• The BoC faces a difficult December rate decision as Canada's labour market remains weak.

Stronger-than-forecast US inflation boosts the US Dollar (USD) on Tuesday, sending USD/CAD to its highest since 16 October. Meanwhile, hopes of US-Iran diplomacy drive oil prices lower, putting additional pressure on the Canadian Dollar (CAD). The pair is trading at around 1.4167 at the time of writing, a gain of 0.34% on the day.

October's US Consumer Price Index (CPI) increased by 0.4% MoM, exceeding the 0.3% forecast, although the rise was smaller than September's 0.6%. Excluding food and energy, core CPI advanced 0.3%, matching September's reading and surpassing expectations of 0.2%. No annual CPI figures for October were published by the Bureau of Labor Statistics (BLS), owing to last year's government shutdown.

With the figures strengthening expectations of a December interest rate rise by the Federal Reserve (Fed), the US Dollar recouped roughly half of its losses from the previous day. From an intraday low of 101.49, the US Dollar Index (DXY) advances towards 102.00.

Ahead of the release, Fed Governor Christopher Waller said that a half-point increase in December might be necessary if October core CPI registered “around 0.3% or higher.” According to the CME FedWatch Tool, traders now put the probability of a 25-basis-point rise at 85.3%, with a 14.7% probability of a 50-basis-point increase.

Geopolitical developments could be crucial to the policy outlook, suggest analysts at MUFG/BTMU. They argue that “if there is further progress towards a US-Iran deal to end the conflict, it would help to sustain lower energy prices and ease pressure on major central banks, including the Fed, to keep hiking rates.”

Down more than 15% so far this month, West Texas Intermediate (WTI) eases towards $84 a barrel, its lowest since 31 August. Following talks with Qatar’s prime minister at the White House on Monday, US President Donald Trump said there was “positive momentum” towards ending the war with Iran.

Lower oil prices can erode Canada's export earnings and put pressure on the Loonie, given the country's position as a major crude exporter. At the same time, uncertainty surrounds a December rate rise by the Bank of Canada (BoC), which must balance efforts to curb inflation against support for a weakening labour market.

Figures published by Statistics Canada on Friday showed a third consecutive monthly decline in Canadian employment in October. Rather than the expected increase of 13.6K, employment dropped by 4.7K.