Canadian Dollar recovers as softer US Dollar offers relief ahead of US CPI

• The Canadian Dollar gains ground as the US Dollar retreats from recent highs.
• Traders await Wednesday’s US CPI report for fresh clues on the Fed’s interest rate outlook.
• Wide US-Canada bond yield gaps and diverging central bank outlooks remain headwinds for the Canadian Dollar.

USD/CAD falls around 0.45% on Tuesday as US Dollar (USD) bulls take a breather ahead of Wednesday’s US inflation report. The pullback gives the Canadian Dollar (CAD) some relief, although diverging monetary policy expectations for the Bank of Canada (BoC) and the Federal Reserve (Fed) could keep the Loonie’s gains in check. At the time of writing, the pair trades around 1.4216.

The US Dollar Index (DXY), which tracks the Greenback against six major currencies, trades around 102.25, below Monday’s peak of 102.61, its highest since April 2025.

Headline Consumer Price Index (CPI) is expected to rise 0.6% MoM, accelerating from 0.4% in August. Annual inflation is forecast to climb to 3.7% from 3.4%. Core CPI, which excludes food and energy, is projected to increase 0.2% monthly from 0.3%, although the annual rate is expected to edge up to 2.5% from 2.4%.

Strategists at OCBC note that markets “currently expect the Fed to remain on hold in October before delivering a fully priced 25bp rate hike in December.” They argue that the “key question for the USD is whether upcoming CPI data can alter that sequencing by bringing forward expectations for further tightening.” While consensus forecasts point to “firmer headline inflation due to higher energy costs,” OCBC highlights that “core inflation is expected to remain relatively contained.”

In their view, “if core inflation moderates as expected, markets could further trim expectations for additional Fed tightening, limiting the scope for further USD gains.” OCBC adds that “it would likely take a core CPI print of 0.4% m/m or higher to materially shift market pricing and strengthen the case for earlier Fed action.” Absent such a surprise, they expect the “USD is likely to remain supported but not break decisively higher.”

Across the broader market, the Canadian Dollar has remained under sustained selling pressure since early September, largely reflecting a widening gap between US and Canadian bond yields as monetary policy expectations diverge.

While markets anticipate further Fed tightening, the case for higher interest rates in Canada remains weaker. The inflationary impact of elevated energy costs has so far been limited, with underlying inflation near the BoC’s 2% target.

Meanwhile, last week’s employment report showed that Canada lost 68.3K jobs in September, marking a second consecutive monthly decline in employment. The weaker labour market gives the BoC another reason to remain cautious about raising interest rates, leaving the Canadian Dollar on the defensive in the near term.