USD/CAD Near 1.425 as Fed Hike Widens Rate Gap With Canada

Rate gaps now matter more than oil for the loonie and the Aussie

With both the Federal Reserve and the Bank of Canada set to announce decisions on October 28, two commodity currencies are moving on the same main driver: the gap between their central bank's rate and the Fed's. The Fed's quarter-point hike in September was its first increase in three years. It turned rate differentials into the biggest force on USD/CAD and AUD/USD, and oil, which once mattered more, now ranks behind them. Brent crude is trading above $100 during the US-Israeli war with Iran, which would normally support the Canadian dollar. Instead the loonie has weakened. The Australian dollar has held up a little better because the Reserve Bank of Australia is also raising rates.

The main conclusion here is that the market sees this as a story about policy divergence first and commodities second. Geopolitical risk is mostly reaching these currencies through US yields and demand for the dollar as a safe haven, not through terms of trade.

What the Fed did, and what it signaled

On September 16, the Federal Open Market Committee voted 12-0 to raise the federal funds target range by 25 basis points to 3.75%-4.00%. It was the first hike since 2023 and ended a pause that had lasted the first five meetings of the year.37 The Board also raised the primary credit rate to 4.0% and the interest rate on reserve balances to 3.90%, both effective September 17.2 The hike followed several late-2025 cuts that had brought the range down to 3.50%-3.75%.8

The reasons given were clear. Chair Kevin Warsh pointed to a stronger labor market, no improvement in inflation trends, and geopolitics, saying "there's no hiding from hot spots around the world."7 August data supported that view. Payrolls rose 162,000, unemployment held at 4.1%, and headline CPI stayed at 3.4% year over year while core inflation eased to 2.4%.17 The energy shock from the Iran war was widely seen as one of the main reasons for the move.4

The forward guidance mattered more for currencies than the hike itself. In the updated dot plot, 16 of 18 officials saw room for at least one more increase this year, and four projected two.4 The median projection puts the funds rate at 4.1% at the end of both 2026 and 2027, with PCE inflation at 3.7% this year.6 Minutes released October 7 showed that most policymakers thought another increase by year-end would likely be appropriate, while saying each meeting remained open.4

The data have since become less clear. September payrolls rose only 29,000, unemployment ticked up to 4.2%, and earlier months were revised lower.12 Markets now price roughly an 81% chance that the Fed holds in October and hikes in December.20 Some analysts had already expected October to be skipped because it falls so close to the midterm elections.7 Fed Governor Christopher Waller has kept arguing for further tightening while staying flexible on timing, and a sentiment gauge of Fed communications remains firmly hawkish.16 The overall message is that the Fed may pause, but it is not changing direction.

USD/CAD: a 175bp gap does most of the work

The Bank of Canada has held its policy rate at 2.25% for seven straight meetings, most recently on September 2.13 With the top of the Fed's range at 4.00%, the policy-rate gap is now 175 basis points. Scotiabank notes that the gap spent much of last year at about that level, and says wider short-term spreads explain the Canadian dollar's underperformance.18

The price action shows how strong that effect has been. Rabobank describes a sharp sell-off in the Canadian dollar from September 9 to October 5. USD/CAD climbed from a September low of 1.373 to about 1.425, where it has stalled after failing to break 1.43.11 At one point the loonie fell in 12 of 13 sessions after Canada's counter-tariffs took effect.13

Forecasters agree on the cause but differ on what comes next. Rabobank is the most bearish on the Canadian dollar. It expects the rate gap to widen to 200 basis points by year-end and USD/CAD to reach 1.45 within three months, helped by possibly higher US yields after the midterms, before easing back toward 1.40 over 12 months.11 A survey of five Canadian banks is more optimistic. It puts October's range at 1.40-1.44 and has the average forecast falling to about 1.39 in the fourth quarter, with individual forecasts from 1.37 to 1.42.12 Scotiabank's fair-value estimate of 1.4068 suggests the US dollar is somewhat overvalued at current levels. The bank also warns that the gap is unlikely to close soon.14

The market also seems to disagree with itself. Canada's growth is weak and its trade relationship with the US is getting worse, yet Canadian overnight index swaps imply almost four Bank of Canada hikes by next September.16 Scotiabank put the pricing at 14 basis points of tightening for October and a cumulative 37 for December.14 One five-bank survey still expects the central bank to stay cautious on October 28, as inflation risks compete with damage from tariffs and spare capacity in the economy.12 My reading is that the hawkish pricing in Canada is the weaker part of the outlook. If the Bank of Canada simply holds, the gap may widen further than futures imply. That supports the view that USD/CAD stays high, even if 1.45 proves too ambitious.

Oil above $100, and a loonie that isn't benefiting

The most notable part of the Canadian story is the oil price. Crude is Canada's largest export, and Brent rose more than 15% in September, yet the Canadian dollar still fell. Analysis noted that the loonie has dropped both when oil rose and when it fell within the same month.13 When oil dipped in late September, with WTI near $93.50, it added to pressure on the currency. When oil rallied, the currency got little help.19

The oil market itself is still being pushed around by the war. Brent rose about 5% to roughly $105 on October 8 after a report that the White House had asked for options to strike Iran before the midterms. That same day, Hurricane Isaias threatened production in the Gulf of Mexico.25 About 63% of US Gulf offshore output, or roughly 1.3 million barrels per day, was shut in before the storm.30 Prices eased on October 9 after President Trump said talks with Iran were productive and ruled out attacks before the November 3 elections. Iran's foreign minister said Tehran was reviewing a US response to a proposal that could reopen the Strait of Hormuz within seven days.29 Brent still settled near $104.72 and WTI near $91.85 as new tanker attacks pushed freight costs to records.22

The oil reporting does not agree on how much of the price is a risk premium. Goldman Sachs estimated a geopolitical premium of about $22 a barrel in September.29 Other analysis argues that $100 Brent is a level set by the market, held by risks pulling in opposite directions. Saudi pipeline flows bypassing Hormuz recovered to 5.8 million barrels per day, and the G7 released 100 million barrels from reserves, both of which limit how high prices can go.2624 Exports through Hormuz have largely returned to pre-war levels, yet prices stay high. One Kpler analyst suggested Gulf exporters may be paying Iran to let shipments through, a claim Washington says it would not accept in any deal.2425

For Canada, there is also a less obvious problem. The discount on Western Canadian Select was about $25 a barrel in early October, which means Canadian producers get much less than headline prices.29 Oil's main effect on the loonie now runs through US inflation, which supports Fed tightening, which pushes US yields higher and widens the gap with Canada. The US 10-year yield has approached 5.2% while Canada's is near 3.95%.13

AUD/USD: a hawkish RBA as partial protection

The Australian dollar has a hawkish central bank of its own. The RBA raised its cash rate to 4.60%, its fourth hike of 2026, and left the door open to more.14 That has not fully protected the currency. AUD/USD slipped below 0.7000 after the decision, and in late September it touched its lowest level since early August. An oil rally revived inflation fears, pushed US yields to multi-year highs, and geopolitical stress sent the dollar to a two-month high.1413

The Australian dollar has recovered recently. It ended the week of October 9 at about 0.6983, up 0.58%, as US consumer sentiment fell to 46.3 and expectations of a Fed pause increased.20 Its technical picture is still weak, with the pair below a cluster of moving averages near 0.7089.20 Forecasters had expected a range of 0.70-0.74 for September and warned that rising geopolitical risk or weak Chinese data would favor the US dollar.17

The October 28 test

Both North American decisions fall on October 28, and the Bank of Canada announces first.139 Warsh speaks on October 16 and the Beige Book is released October 14, before then.4 The way the Fed is managing expectations points to a hawkish hold, with a December hike left open. For USD/CAD, the risk is uneven. A cautious Bank of Canada would undercut market pricing for Canadian hikes and widen the rate gap. A rebound in US data would bring December back into play. For both currencies, any deal that reopens Hormuz would remove some of the oil premium and the dollar's safe-haven bid together. Comparing the forecasts, that kind of de-escalation looks more likely to lift the Canadian and Australian dollars than any rise in oil prices.