Fed-BoC policy divergence in focus as Canadian Dollar prolongs winning run

• Below 1.4000: USD/CAD heads for a second straight weekly fall.
• Higher oil prices and BoC rate-hike expectations sustain pressure on the pair.
• Next week’s Fed and BoC decisions are in focus as traders assess the interest-rate outlook.

USD/CAD trades near 1.3975 at the time of writing. The pair fell below 1.4000 to a one-month low on Friday, extending its decline to seven consecutive days and putting it on course for a second straight weekly loss. Traders anticipate diverging policy paths from the Federal Reserve (Fed) and the Bank of Canada (BoC) at next week’s meetings. That outlook underpins the Canadian Dollar (CAD), with rising oil prices tied to Middle East tensions adding support.

Roughly half of September’s USD/CAD rally has now been erased. Expectations are building that the BoC could announce its first rate increase of the year at the October 28 meeting, as energy-related inflation risks intensify. In September, Canada’s annual inflation rate climbed to 3.1%, a four-month high.

Canadian Retail Sales increased 1.2% in August, Friday’s data showed, reversing July’s 0.8% fall but falling slightly short of the 1.3% forecast. Sales excluding autos also advanced 1.2%, exceeding the 1.0% expected rise following a 0.8% contraction.

TD Securities describes a BoC move in October as “reckless. Not necessarily wrong. But a needless risk.” 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.”

Calling the decision a “close call,” TD Securities says it “would avoid any outright positions heading into the meeting.” The firm observes that “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.” Its 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.”

In the US, the dollar is holding steady following a recent decline driven by lower Treasury yields. Doubts about the sustainability of AI-related investment had pressured equities and drawn investors into government bonds. After reaching 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 point increase, the Fed is widely expected to keep rates on hold next week. Attention will centre on how policymakers weigh energy-led inflation against the risk that slower AI-related investment could dampen economic growth. Markets continue to assign an 80% probability to a December rate increase. A more cautious Fed message, however, could leave the US Dollar under renewed pressure.