Canadian Dollar stabilises as US Dollar recovery caps further gains

• A US Dollar recovery from three-week lows helps USD/CAD recoup part of its decline.
• Middle East supply concerns lift oil prices, lending support to the Canadian Dollar.
• Next week’s Fed and BoC rate decisions remain in focus for traders.

Having touched 1.4013, its lowest level in a month, USD/CAD has recovered some ground on Thursday and trades at around 1.4032 at the time of writing. The partial reversal of its earlier losses comes as the US Dollar (USD) attempts to recover from a fresh three-week low reached during Asian trading. Further gains remain constrained, however, as higher oil prices linked to Middle East tensions help the Canadian Dollar (CAD) outperform most major currencies.

Growing unease over AI-related investments has triggered a global equity sell-off, leaving market sentiment fragile. Demand for government bonds has strengthened as a result, driving yields down across major economies.

At around 5.03%, the benchmark 10-year US Treasury yield is down 1.50% on the day, having reached 5.36% earlier this month. Falling Treasury yields have been accompanied by a weaker Greenback since the US Dollar Index (DXY) neared 103.00 last week.

Signs of renewed demand for the US Dollar nevertheless suggest that some traders are seeking safety in the currency, which also retains underlying support from the prospect of higher US interest rates. After an intraday low of 101.45, the DXY stands at around 101.78. The index measures the Greenback against a basket of six major currencies.

Central banks continue to adopt a hawkish stance as energy-related price pressures stemming from the Middle East war feed into global inflation. Reports that the US and Israel are considering fresh strikes on Iran after the US midterm elections have lifted oil prices to five-week highs. Continuing Houthi attacks in Saudi Arabia are also increasing the risks to supplies across the Gulf region.

Expectations that central banks will have to retain restrictive monetary policies have strengthened as the continuing energy shock threatens to prolong elevated inflation. Attention now turns to next week’s Federal Reserve (Fed) monetary policy meeting. Following a 25 basis points (bps) increase in September, the US central bank is widely expected to hold interest rates steady.

With another rate rise in December priced in by traders, markets will scrutinise the Fed’s guidance for indications of its next step. The CME FedWatch Tool puts the probability of a December increase at around 89%.

For the Bank of Canada (BoC), meanwhile, expectations of the year’s first rate increase at its 28 October meeting are building. Monday’s figures showed annual Canadian inflation accelerating to 3.1% in September, a four-month high, as petrol prices rose.

The substantial gap between US and Canadian yields and interest rates should nonetheless limit the Loonie’s gains. The yield on Canada’s benchmark 10-year government bond is around 3.81%.