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US Canadian Dollar Exchange Rate Tumbles Ahead of Federal Reserve Decision

December 19, 2018 - Written by David Woodsmith

Despite a combination of weaker than expected Canadian inflation data, as well as oil prices recently hitting their worst levels in over a year, the US Dollar to Canadian Dollar (USD/CAD) exchange rate slipped on Wednesday afternoon as investors anticipated the Federal Reserve’s December policy decision.

Since opening this week at the level of 1.3382, USD/CAD has trended with an upside bias. USD/CAD has climbed continuously in recent months, and on Tuesday night hit a 2018 high of 1.3493. Since then, USD/CAD has slipped slightly though.

At the time of writing on Wednesday afternoon, Federal Reserve jitters were limiting US Dollar strength and USD/CAD was trending nearer the level of 1.3425.

USD Exchange Rates Slip Ahead of Federal Reserve Policy Decision

The US Dollar saw mixed movement on Wednesday, briefly holding its ground earlier in the day before tumbling as the Federal Reserve’s highly anticipated December policy decision drew nearer.

Markets expect the Federal Reserve to confirm that US interest rates will be hiked for the fourth time this year, but uncertainties arise in regards to the bank’s 2019 policy outlook.

Federal Reserve Chairman Jerome Powell has said recently that the US interest rate is just below neutral, meaning US interest rates may not be hiked much higher before the Federal Reserve’s rate hike cycle comes to a pause or an end.

Investors became anxious that the Federal Reserve’s 2019 monetary policy outlook, which was expected to be more hawkish mere months ago, may not see any interest rate hikes at all or may only see one or two, dependant on US data.

Markets were also rattled by criticism from US President Donald Trump, aimed at the Federal Reserve’s interest rate hikes. According to Kit Juckes, Global Head of FX Strategy at Societe Generale:

‘A hike is still likely, regardless of Trump's displeasure, but there's a very good chance that they will reduce the number of hikes in 2019 to two (from three),’

Analysts generally noted that investor anxiety that the Federal Reserve could become more cautious next year due to US and global growth concerns were the cause of US Dollar weakness. According to Michael McCarthy, Chief Markets Strategist at CMC Markets:

‘The positioning going into the FOMC meeting is very defensive and that's why we are seeing the Dollar weakening,’

CAD Exchange Rates Gains Limited as Oil Prices Weaken and Canadian Inflation Misses

Canada’s November Consumer Price Index (CPI) inflation rate report was published on Wednesday and revealed that Canada’s inflation rate had fallen even more year-on-year than expected.

The yearly inflation rate was forecast to slide from 2.4% to 1.8%, but instead plunged to just 1.7%. The monthly rate contracted at -0.4% as expected. Weaker inflation was caused by falling gas prices as well as general weakness in price pressures.

As a result of the weaker Canadian inflation data, market Bank of Canada (BoC) interest rate hike bets fell. According to Derek Holt, Vice President of Capital Market Economics at Scotiabank, the data will give the BoC little reason to hike rates for the next quarter:

‘That informs a near-term dovish Bank of Canada. No hike in the first quarter (of 2019), probably returning to a hike in April is still our call,’

It followed weeks of poor performance in prices of oil, Canada’s most lucrative commodity. Oil prices hit their lowest levels in over a year this week.

This news weighed heavily on the Canadian Dollar and prevented the currency from capitalising on the US Dollar’s weakness this week.

USD/CAD Exchange Rate Forecast: Fed Decision and Canadian Data Ahead

The US Dollar’s weakness in recent sessions has prevented the US Dollar to Canadian Dollar exchange rate from holding its best 2018 levels, but this could change if the Federal Reserve is less cautious this evening than markets expect.

Investors are increasingly expecting the Fed to dial back its 2019 interest rate hike plans and signal that the rate hike cycle is coming to an end. As a result, if the bank is more hawkish than that then USD/CAD could surge.

However, even if the Federal Reserve does take a more dovish tone, the US Dollar to Canadian Dollar exchange rate may not weaken much as the Canadian Dollar remains unappealing.

If oil prices start to see a more solid recovery in the coming sessions the Canadian Dollar could strengthen.

Demand for the US Dollar to Canadian Dollar exchange rate could also be influenced by Canadian wholesale sale stats on Thursday, or Canada’s key growth rate or retail sales results on Friday.
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