Can the Canadian Dollar withstand pressure as US CPI strengthens the hawkish Fed outlook?

• A recovery in the US Dollar after October's inflation release pushes USD/CAD higher.
• Another December Fed rate hike is priced in by traders as US CPI exceeds expectations.
• The BoC faces a tougher December rate decision as Canada's labour market remains weak.

USD/CAD advances on Tuesday to its highest point since 16 October, supported by a firmer US Dollar (USD) and renewed pressure on the Canadian Dollar (CAD). US inflation exceeded expectations, boosting the greenback, while hopes of progress in US-Iran diplomacy drove Oil prices lower and weighed further on the CAD. The pair is trading near 1.4167 at the time of writing, a gain of 0.34% for the day.

October's US Consumer Price Index (CPI) increased 0.4% MoM, exceeding the 0.3% forecast while moderating from September's 0.6% rise. Excluding food and energy, core CPI advanced 0.3%, matching September's pace but surpassing expectations of 0.2%. Annual CPI figures for October were not released by the Bureau of Labor Statistics (BLS) owing to last year's government shutdown.

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

A half-point Fed rate increase in December may be necessary if October core CPI is “around 0.3% or higher.” That was the view expressed by Fed Governor Christopher Waller ahead of the release. According to the CME FedWatch Tool, traders now put the probability of a 25-basis-point hike at 85.3% and that of a 50-basis-point increase at 14.7%.

Geopolitical developments could be crucial to the policy outlook, in the view of 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.”

With losses exceeding 15% so far this month, West Texas Intermediate (WTI) is edging down towards $84 a barrel, its weakest level since 31 August. Following discussions with Qatar’s prime minister at the White House on Monday, US President Donald Trump said there was “positive momentum” towards bringing the war with Iran to an end.

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 over a December rate hike persists as the Bank of Canada (BoC) weighs the need to curb inflation against support for a deteriorating labour market.

A decline of 4.7K in Canadian employment during October contrasted with forecasts for an increase of 13.6K. The Statistics Canada figures, published on Friday, marked a third consecutive month of job losses.