Canadian Dollar remains vulnerable aas Fed takes centre stage
- USD/CAD advances for a fifth straight day as the US Dollar remains firm ahead of the Fed decision.
- WTI Oil trades around $100, limiting losses in the commodity-linked Canadian Dollar.
- The 10-year US Treasury yield rises above 5%, reaching its highest level since 2007.
USD/CAD extends its advance for a fifth consecutive day on Tuesday, hovering near a two-week high as the US Dollar (USD) stays firmly supported ahead of the Federal Reserve’s (Fed) monetary policy announcement on Wednesday. However, rising Oil prices offer some support to the commodity-linked Canadian Dollar (CAD), keeping the pair’s gains contained. At the time of writing, USD/CAD trades around 1.3913, little changed on the day.
Markets are almost fully pricing in a Fed rate hike on Wednesday as the energy shock stemming from the war in the Middle East complicates the central bank’s task of bringing inflation sustainably back toward its 2% target. Headline Consumer Price Index (CPI) inflation stood at 3.4% YoY in August, while the Producer Price Index (PPI) accelerated to 5.4%.
Reflecting these concerns, the benchmark 10-year US Treasury yield climbed above 5% on Tuesday, reaching its highest level since 2007. Hawkish Fed expectations and elevated Treasury yields keep the US Dollar supported. The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, trades near 99.60, close to a two-week high.
With a quarter-point Fed hike largely priced in, attention will turn to the updated economic projections and comments from Fed Chairman Kevin Warsh, particularly how policymakers assess Oil-driven inflation as the war in the Middle East shows no signs of ending and could keep energy prices elevated for the foreseeable future.
West Texas Intermediate (WTI) Oil trades above $100 a barrel, around levels last seen on May 21. Higher Oil prices typically support the Canadian Dollar because Canada is a major crude exporter. However, the Loonie struggles to capitalise as a firmer US Dollar and hawkish Fed expectations remain the stronger forces, while the Bank of Canada’s (BoC) steady policy approach leaves the interest rate gap tilted in favour of the Greenback.
Strategists at Scotiabank note that the latest Canadian CPI release was “broadly in line with expectations” and “did little for the CAD or for short-term rates,” but they stress that “toasty underlying trends in core measures maintain the focus on price risks and the potential for the BoC to start normalizing still accommodative monetary policy later this year.”
On the technical side, they “continue to note a significant resistance zone between the low/mid 1.39s, however, defined by trend resistance, the 40-and 100-day moving averages, retracement resistance, and the early September high,” while flagging that “initial USD support is 1.3825/30 and 1.3730/60.”
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
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