1.4230: Canadian Dollar hits four-week lows as Fed tightening bets boost the Greenback

USD/CAD rallies nearly 2% in less than one week and hits fresh four-week highs at 1.4230 so far.
Hotter-than-expected US inflation and a solid labour market have cemented hopes of at least a quarter-point rate hike at the next Fed meeting.
The diverging employment data between the US and Canada released on Friday is likely to keep the pair above 1.4000, according to TD Securities' experts.

The Canadian Dollar (CAD) has resumed its downtrend, with the US Dollar (USD) rallying across the board on Wednesday as investors ramp up hopes of Federal Reserve (Fed) tightening in December. The USD/CAD pair trades at fresh four-week highs at 1.4230 at the US session opening, after rallying nearly 2% in less than a week.

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Speculative investors have boosted the Greenback since the US Bureau of Labour Statistics (BLS) revealed that consumer inflation grew beyond expectations in October. These figures, coupled with the bright Nonfarm Payrolls (NFP) report released on Friday, have boosted expectations that the Fed will hike rates by at least a quarter-point at its December meeting.

Fed officials support bets of at least a quarter-point hike in December

These hopes were supported by Fed officials late Tuesday, as the President of the Philadelphia Fed, Anna Paulson, hinted at “further gradual tightening” ahead to bring inflation to target. The President of the Dallas Fed, Lorie Logan, highlighted a similar stance, affirming that “the Fed needs at least two more quarter-percentage-point increases.”

Before the US Consumer Price Index (CPI) release, Fed Governor Christopher Waller had stated that he would back a 25-basis-point hike if inflation came at 0.3% or higher –it came out 0.4% up, finally–, adding that “I believe a 50-basis-point hike in the policy rate should be considered”. Futures markets ramped up bets of a jumbo rate hike in December to 12% from practically none last week, according to data by the CME’s FedWatch Tool.

In Canada, the scenario is quite different, as October's employment report, which was released simultaneously with the US NFP data, showed a net loss in employment and rising unemployment. Analysts at TD Securities argue that “diverging employment data releases will likely keep USDCAD supported above 1.40,” as a “rising unemployment rate amid falling wage growth rate in Canada also reduces the market pricing of a December BoC rate hike relative to the Fed.” In their view, this combination of softer Canadian labour dynamics and a comparatively more hawkish Fed should keep the Canadian Dollar under pressure for now.

Interest rates FAQs

What are interest rates?

Interest rates are charged by financial institutions on loans to borrowers and are paid as interest to savers and depositors. They are influenced by base lending rates, which are set by central banks in response to changes in the economy. Central banks normally have a mandate to ensure price stability, which in most cases means targeting a core inflation rate of around 2%. If inflation falls below target the central bank may cut base lending rates, with a view to stimulating lending and boosting the economy. If inflation rises substantially above 2% it normally results in the central bank raising base lending rates in an attempt to lower inflation.

How do interest rates impact currencies?

Higher interest rates generally help strengthen a country’s currency as they make it a more attractive place for global investors to park their money.

How do interest rates influence the price of Gold?

Higher interest rates overall weigh on the price of Gold because they increase the opportunity cost of holding Gold instead of investing in an interest-bearing asset or placing cash in the bank. If interest rates are high that usually pushes up the price of the US Dollar (USD), and since Gold is priced in Dollars, this has the effect of lowering the price of Gold.

What is the Fed Funds rate?

The Fed funds rate is the overnight rate at which US banks lend to each other. It is the oft-quoted headline rate set by the Federal Reserve at its FOMC meetings. It is set as a range, for example 4.75%-5.00%, though the upper limit (in that case 5.00%) is the quoted figure. Market expectations for future Fed funds rate are tracked by the CME FedWatch tool, which shapes how many financial markets behave in anticipation of future Federal Reserve monetary policy decisions.

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