Canadian Dollar falls as US-Canada rate gap seen widening further

USD/CAD extends its gains for the sixth consecutive day, trading around 1.4150 during Asian hours on Monday. The pair appreciates as the Canadian Dollar (CAD) is declining under pressure from expectations of a widening interest-rate differential between the United States (US) and Canada. This gap is expected to grow after the Bank of Canada (BoC) kept its key policy rate unchanged at 2.25% at its September meeting.

CAD under pressure as US-Canada spreads loom but move seen as stretched

Strategists at Scotiabank observe that “wider US-Canada spreads have been a major headwind for the CAD over the past couple of weeks,” leaving the currency under pressure against the USD and lagging most of its G10 peers. However, they add that “the move feels somewhat stretched,” arguing that there is “limited scope for further tightening in Fed expectations while the BoC feels somewhat underpriced,” suggesting the recent underperformance of the Canadian Dollar may be overdone.

However, elevated oil prices continue to put upward pressure on Canadian inflation. Traders are looking for fresh catalysts while closely monitoring geopolitical developments in the Middle East. Market sentiment remains tied to the region after US President Donald Trump rejected Iran’s latest proposal to reopen the Strait of Hormuz, stating that Tehran had overplayed its hand, though he noted negotiations are expected to resume this week.

Furthermore, President Trump expressed confidence that the conflict with Iran would conclude soon, while keeping open the possibility of additional military strikes before the midterm elections.

The Federal Reserve (Fed) raised its federal funds target range at its latest meeting, reinforcing the US Dollar's (USD) advantage over the Canadian Dollar. Money markets are now pricing in a 65.9% chance of another benchmark rate hike at the October Fed meeting, up significantly from 57.6% a week ago and just 9.4% a month ago.

Traders are turning their focus toward key economic indicators due this week. Market attention is centered on upcoming US employment data and the Fed’s preferred inflation gauge to gauge the future trajectory of monetary policy.

Last week, Cleveland Fed President Beth Hammack warned against allowing the public to accept elevated prices as the norm. Echoing this sentiment, Philadelphia Fed President Anna Paulson noted that modest further tightening may be warranted.