Canadian Dollar steadies as US Dollar recovery limits further upside

• USD/CAD pares some losses as the US Dollar rebounds from three-week lows.
• Rising Oil prices underpin the Canadian Dollar as Middle East tensions raise supply concerns.
• Traders await next week's Fed and BoC interest rate decisions.

USD/CAD trims part of its earlier losses on Thursday as the US Dollar (USD) attempts a rebound after slipping to a fresh three-week low earlier in Asian trading hours. However, the upside remains limited as the Canadian Dollar (CAD) outperforms most of its major peers, supported by rising Oil prices amid tensions in the Middle East. At the time of writing, USD/CAD trades around 1.4032, after hitting an intraday low of 1.4013, its lowest level in a month.

Meanwhile, market sentiment remains fragile as a sell-off in global equities, driven by mounting concerns over AI-related investments, fuels demand for government bonds and pushes yields lower across major economies.

The benchmark 10-year US Treasury yield trades around 5.03%, down 1.50% on the day after reaching a high of 5.36% earlier this month. The Greenback has weakened alongside falling Treasury yields after the US Dollar Index (DXY) approached the 103.00 mark last week.

However, renewed buying interest in the US Dollar suggests that some traders are turning to the Greenback for safety, while prospects of higher US interest rates continue to provide underlying support. The DXY, which tracks the Greenback's value against a basket of six major currencies, trades around 101.78 after touching an intraday low of 101.45.

Energy-driven inflation risks linked to the war in the Middle East continue to feed into global inflation, prompting central banks to maintain a hawkish stance. Oil prices have climbed to five-week highs following reports that the US and Israel are considering renewed strikes against Iran after the US midterm elections. At the same time, continued Houthi attacks in Saudi Arabia are adding to supply risks across the Gulf region.

The ongoing energy shock threatens to keep inflation elevated for longer, strengthening expectations that central banks will need to maintain restrictive monetary policies. Traders now look ahead to next week's Federal Reserve (Fed) monetary policy meeting, where the US central bank is widely expected to leave interest rates unchanged after raising them by 25 basis points (bps) in September.

Markets will closely watch for clues about the Fed's next move, with traders pricing in another rate hike in December. According to the CME FedWatch Tool, the probability of a December rate increase stands at around 89%.

Meanwhile, expectations are growing that the Bank of Canada (BoC) will deliver its first rate hike of the year at its October 28 meeting. Data released on Monday showed that Canada's annual inflation rate rose to 3.1% in September, its highest level in four months, driven by higher gasoline prices.

However, the wide yield and interest rate gap between the US and Canada should keep gains in the Loonie in check. Canada's benchmark 10-year government bond yield stands around 3.81%.