USD/CAD hovered near 1.3950 on Tuesday after ending a four-day advance, easing from Monday’s two-month high of 1.3961 as the US Dollar ceded some gains ahead of the Bank of Canada decision. Risk appetite improved after Iran and Israel agreed to halt mutual attacks following an appeal from US President Donald Trump, which reduced safe-haven demand for the greenback. Caution persisted, however, after reports said the Israeli military ordered the immediate evacuation of parts of Tyre ahead of potential strikes, while Israeli Prime Minister Benjamin Netanyahu said the conflict with Iran and Hezbollah “has not yet ended.”
In the US, markets continued to weigh the Federal Reserve outlook, with stronger labour data reviving inflation concerns and lifting expectations for further tightening. The CME FedWatch tool puts the probability of a 25-basis-point December hike at 43%, compared with 14% a month ago, while CPI data on Wednesday and PPI on Thursday are in focus. The Canadian Dollar remained pressured by softer oil prices, even as views on the economy diverged: Rabobank pointed to two consecutive quarters of GDP contraction, while RBC argued the GDP data overstate weakness due to an exceptional drop in population growth. For Wednesday’s BoC meeting, markets largely expect the policy rate to stay at 2.25%, a level Rabobank also sees holding through year-end.
Central Bank Decisions And Inflation Data In Focus
With USD/CAD pausing near a two-month high of 1.3961, we view this pullback as a positioning adjustment ahead of key events. The Bank of Canada’s decision on Wednesday is the next major catalyst, though we expect them to hold rates steady at 2.25%. The real market-moving information will come from the tone of the central bank’s statement and the upcoming US inflation data.
Our primary focus remains on the upcoming US inflation data, as the Federal Reserve’s path is the market’s main driver. After the recent Non-Farm Payrolls report showed a surprising addition of 295,000 jobs, a hot CPI reading could easily push December rate hike odds above 60% from the current 43%. We are positioning for increased volatility in US Treasuries and the dollar index around the CPI release.
Tactical Positioning Amid Geopolitical And Market Volatility
For the Canadian dollar, we are less concerned with the BoC’s rate decision itself than its forward guidance. With WTI crude oil having recently broken below $75 a barrel, any dovish language from the central bank could significantly weaken the loonie. This contrasts with the situation in late 2022, when high oil prices forced the BoC into a more hawkish stance despite slowing growth.
The fragile truce between Iran and Israel suggests that implied volatility is currently underpriced. We’ve seen the VIX index dip below 14 this week, a level that historically has not persisted during periods of unresolved geopolitical conflict. Therefore, we are buying cheap, out-of-the-money VIX call options as a portfolio hedge against a sudden flare-up.
Given these conflicting signals, we are using options to express our view on USD/CAD rather than holding a direct spot position. We favor buying July call options with a strike price around 1.4050, as this offers upside exposure if US data surprises and the BoC remains cautious. This strategy limits our risk to the premium paid, which is prudent until we get more clarity from the central banks.
