Canadian Dollar holds steady as US inflation boosts US Dollar while Oil cushions CAD

• The US Dollar remains supported after a sharp acceleration in US producer inflation.
• US Treasury yields rise as markets push back expectations for Federal Reserve easing.
• Elevated Oil prices continue to limit Canadian Dollar losses and support the Loonie.

USD/CAD trades without a clear direction on Wednesday, hovering around 1.3700 at the time of writing, as investors balance persistent US Dollar (USD) strength against support for the Canadian Dollar (CAD) from elevated Oil prices. The pair remains close to its four-week highs, supported by rising US yields and a reassessment of Federal Reserve (Fed) policy expectations.

Inflation concerns continue to dominate financial markets. Geopolitical tensions in the Middle East and stalled negotiations between the United States (US) and Iran are keeping Oil prices elevated, fueling fears of more persistent global inflation. This backdrop is prompting major central banks to maintain restrictive monetary policy for longer than previously expected.

In the United States, the Producer Price Index (PPI) accelerated to 6% YoY in April from 4.3% previously, reaching its highest level in four years and beating market expectations by a wide margin. The core PPI, which excludes volatile components, rose 5.2% YoY after 4% in March. These figures follow Tuesday’s Consumer Price Index (CPI) release, which had already shown stronger-than-expected consumer inflation.

The Bond market reaction was immediate. The US 10-year Treasury yield climbed toward 4.49%, supporting the US Dollar. The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, also advances toward 98.50.

Against this backdrop, money markets have significantly reduced expectations for Fed rate cuts. Investors now expect monetary policy to remain unchanged for an extended period, while some traders are even starting to price in the risk of another rate hike before year-end.

The Canadian Dollar (CAD), however, remains supported by firm Oil prices, as Oil is Canada’s main export. West Texas Intermediate (WTI) crude remains close to $98 per barrel, supporting Canada’s trade revenues and limiting further upside in USD/CAD.

Investors are also monitoring the release of the Bank of Canada (BoC) meeting minutes. Strategists at TD Securities believe markets will look for more details on geopolitical risks, the impact of higher Oil prices, and potential divisions within the Governing Council regarding future rate cuts or hikes.

Meanwhile, Scotiabank analysts believe the Canadian Dollar remains undervalued relative to their fair value estimate near 1.3510. However, the bank notes that widening short-term rate spreads in favor of the United States continue to provide near-term support for the US Dollar.