Canadian Dollar Slips as Fed and BoC Decisions Loom

Key Moments

Dollar Strength Pressures CAD Ahead of Fed and BoC Meetings

USD/CAD advanced for a second straight session, trading near 1.4020 in early Asian dealings on Tuesday, as broad U.S. Dollar strength weighed on the Canadian Dollar. The move came with investors positioning cautiously before closely watched interest rate decisions from both the U.S. Federal Reserve (Fed) and the Bank of Canada (BoC), scheduled for Wednesday.

Market expectations indicated that the Fed was likely to leave interest rates unchanged at its upcoming October meeting, while keeping the door open for further tightening later in the year. The CME FedWatch Tool showed that traders assigned an 89.5% probability to a pause in October, alongside an 82.3% likelihood of a rate increase in December.

Heather Long, chief economist at Navy Federal Credit Union, said that “Inflation is still the No. 1 problem in the US economy, and there are a lot of signs it is getting more broad-based.” “For consumers, it means really high borrowing costs for the foreseeable future.” However, “given that it’s right before an election,” Heather added, “they won’t hike in October.”

Oil Price Decline Undermines Commodity-Linked Loonie

The Canadian Dollar, often sensitive to commodity price moves, came under additional pressure as crude oil prices declined. The drop in oil followed renewed diplomatic engagement in the Middle East, which boosted hopes that a broader escalation of tensions involving the United States and Iran could be avoided.

Islamic Republic of Iran Broadcasting (IRIB) reported that Iran, Saudi Arabia, Pakistan, and Turkey agreed on Monday to continue security consultations and deepen regional cooperation after high-level talks in Tehran. A joint communiqué issued after the first meeting between Iran and senior representatives from the Mecca Joint Defence Agreement stated that the four nations had committed to ongoing dialogue and consultations, with a focus on regional peace, security, and stability.

Canada-U.S. Trade Stance Unchanged, Says Prime Minister

On the trade front, Canadian Prime Minister Mark Carney stated on Monday that Canada had not altered its position in negotiations with the United States. He indicated that any headway achieved in the talks reflected Washington moving closer to Canada’s stance.

BoC Outlook: Markets Position for Multiple Hikes Through 2027

Analysts at Commerzbank flagged a notable shift in expectations for the Bank of Canada after recent remarks from Governor Tiff Macklem. They argued that “Macklem’s latest comments have significantly increased the risk of an imminent rate hike, and we therefore expect an initial move before the end of this year.”

According to their assessment, “market participants assign an 85% probability to a rate hike this week, and we also expect a hike given the recent more hawkish comments,” while adding that “we nevertheless consider such a move due to the subdued core inflation premature.” Looking further out, Commerzbank noted that “a total of four rate hikes are priced in by September 2027,” illustrating the extent to which investors have recalibrated their assumptions for the BoC’s policy trajectory.

Canadian Dollar: Key Drivers and Macro Linkages

The performance of the Canadian Dollar (CAD) is closely tied to several fundamental drivers, including interest rate settings by the Bank of Canada, oil prices, domestic economic conditions, inflation trends, and the country’s trade balance. The trade balance captures the gap between Canada’s export revenues and import costs. Market sentiment also matters: a risk-on environment, where investors favor riskier assets, tends to support CAD, while risk-off conditions typically benefit safe-haven currencies at the expense of the Canadian Dollar. Given the importance of the United States as Canada’s largest trading partner, the state of the U.S. economy is also a critical influence on CAD.

Role of the Bank of Canada in Shaping CAD

The Bank of Canada has a central role in determining the value of the Canadian Dollar through its control over short-term interest rates, which in turn affect borrowing costs throughout the economy. Its primary objective is to keep inflation within a 1-3% range by adjusting policy rates higher or lower as needed. Relatively higher interest rates are generally supportive of CAD. The BoC can also deploy quantitative easing or quantitative tightening to influence financial conditions, with easing typically seen as negative for CAD and tightening viewed as supportive.

Oil, Inflation, and Economic Data as Market Catalysts

Oil prices are a crucial variable for CAD because petroleum is Canada’s largest export. Shifts in oil prices can translate quickly into moves in the currency: rising oil prices usually bolster CAD as global demand for Canadian exports increases, while falling prices can weaken it. Higher oil prices also tend to improve Canada’s trade balance, which can further underpin the currency.

Inflation dynamics also feed into CAD’s valuation. Although inflation traditionally reduces the purchasing power of money, in recent decades the link between inflation and currencies has been influenced by cross-border capital flows. Higher inflation often leads central banks to raise interest rates, attracting capital from global investors seeking higher yields. This can boost demand for the local currency, including the Canadian Dollar.

Broader macroeconomic indicators, such as GDP, Manufacturing and Services PMIs, labor market figures, and consumer confidence surveys, provide signals about the strength of Canada’s economy. Robust data can support CAD by drawing in foreign investment and potentially prompting the BoC to tighten policy. Conversely, weaker readings tend to pressure the currency lower by dampening expect