Canadian Dollar extends winning run as markets focus on Fed-BoC policy divergence

• Below 1.4000, USD/CAD is set for its second successive weekly fall.
• Higher oil prices and anticipated BoC tightening maintain downward pressure on the pair.
• Next week’s Fed and BoC policy decisions are in focus as traders seek guidance on rates.

Below 1.4000 on Friday, USD/CAD reaches a one-month low and extends its decline to seven consecutive days. Traders anticipate diverging policy paths from the Federal Reserve (Fed) and the Bank of Canada (BoC) at next week’s meetings, lending support to the Canadian dollar (CAD). Rising oil prices associated with Middle East tensions offer the currency further support. Trading at around 1.3975 at the time of writing, the pair is heading for its second successive weekly loss.

With Canada’s annual inflation rate climbing to a four-month high of 3.1% in September, mounting energy-related inflation risks have fuelled expectations that the BoC could announce its first rate increase of the year at its meeting on 28 October. Against that backdrop, USD/CAD has surrendered roughly half of September’s gains.

Canadian retail sales increased by 1.2% in August, Friday’s figures showed, following a 0.8% fall in July. Although the headline rise fell just short of the 1.3% forecast, sales excluding cars outperformed: growth of 1.2% exceeded the 1.0% expected, following a decline of 0.8%.

An October rate move by the BoC would, in TD Securities’ assessment, be “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.”

Describing the decision as a “close call,” TD Securities says its strategists “would avoid any outright positions heading into the meeting.” The firm contrasts the central banks’ recent signals, noting 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.”

Meanwhile, the US dollar is holding steady following recent losses linked to lower Treasury yields. Concerns about the sustainability of AI-related investment had weighed on shares and encouraged investors to seek government bonds. Having reached a three-week low of 101.45 on Thursday, the US Dollar Index (DXY) now stands at around 101.70. The index measures the greenback against a basket of six major currencies.

Following September’s increase of 25 basis points, the Fed is widely expected to keep rates on hold next week. Attention will centre on policymakers’ assessment of energy-driven inflation risks alongside concerns that weaker AI-related investment could restrain economic growth. Although markets continue to assign an 80% probability to a December rate rise, a more cautious tone from the Fed could leave the US dollar under renewed pressure.