Fed-BoC policy divergence takes centre stage as Canadian Dollar adds to winning streak

• A second straight weekly loss looms for USD/CAD as it falls below 1.4000.
• Pressure on the pair persists as Oil advances and markets anticipate a BoC rate increase.
• Next week’s Fed and BoC policy announcements are in focus as traders seek interest-rate guidance.

Selling pressure pushes USD/CAD below 1.4000 to a one-month low on Friday, marking its seventh consecutive day of losses. The Canadian Dollar (CAD) is benefiting from expectations that the Federal Reserve (Fed) and the Bank of Canada (BoC) will pursue different policy paths at next week’s meetings. Oil’s rise on Middle East tensions offers further support to the currency. Trading near 1.3975 at the time of writing, the pair is poised to post a second straight weekly fall.

With energy-related inflation risks intensifying, expectations are building that the BoC may announce its first rate increase of the year at the meeting on October 28. Against this backdrop, USD/CAD has given back roughly half of September’s gains. Annual inflation in Canada climbed to 3.1% in September, reaching a four-month high.

Canada’s Retail Sales rebounded by 1.2% in August following July’s 0.8% contraction, Friday’s figures showed. The gain fell marginally short of the 1.3% forecast. Sales excluding autos also increased by 1.2%, exceeding the projected 1.0% rise after a decline of 0.8%.

An October rate move by the BoC would be “reckless. Not necessarily wrong. But a needless risk.” according to TD Securities. Its rates strategists consequently “look for the Bank of Canada to hold at 2.25% in October, before hiking 25bps in December,” with “an additional 25bp hike in January, bringing the overnight rate to the mid-point of the Bank's range of neutral rate estimates.”

Describing the decision as a “close call,” TD Securities says its strategists “would avoid any outright positions heading into the meeting.” The strategists highlight the contrast in central bank communication: “recent Fedspeak has been emphasizing a more gradual path to hiking rates and lower urgency, while Macklem has surprised markets with the seemingly aggressive stance he has taken in recent communications.” Their assessment is that “heading into the meeting, there is a more widely accepted expectation that the Fed holds, setting up for an asymmetry that favours CAD outperformance.”

Meanwhile, the US Dollar is holding steady following a recent bout of weakness linked to declining Treasury yields. Concerns about the sustainability of AI-related investments had hurt equities and drawn investors towards government bonds. After hitting a three-week low of 101.45 on Thursday, the US Dollar Index (DXY) is trading near 101.70. The index measures the Greenback against a basket of six major currencies.

Following September’s 25 basis points increase, the Fed is widely expected to keep interest rates on hold next week. Attention will centre on how policymakers weigh inflation pressures arising from energy prices against worries that slower AI-related investment could undermine economic growth. Although markets continue to assign an 80% probability to a December hike, renewed US Dollar pressure could follow a more cautious Fed message.