USD/CAD slides to session lows in Tokyo as US dollar pulls back

• USD/CAD slides in Tokyo in fragile market conditions ahead of the Fed.
• Fed has scope for a much higher terminal rate relative to the Bank of Canada.

USD/CAD is pressured in Tokyo as the US dollar slides deeper below the 20-year highs that were scored against a basket of currencies on Monday. At the time of writing, USD/CAD is trading at 1.2843 and down some 0.25%, falling from a high of 1.2881 to a low of 1.2841 so far. 

The Federal Reserve is expected to hike rates 50 bp to 1.0% Wednesday. While there will be no new forecasts until the June 14-15 FOMC meeting, another 50 bp hike is widely expected then also. In fact, as analysts at Brown Brothers Harriman note, WIRP suggests nearly 50% odds of a 75 bp hike then. 

''Looking further out,'' the analysts said, ''the swaps market is now pricing in 300 bp of tightening over the next 12 months that would see the Fed Funds rate peak near 3.5%. Because of the media blackout, there are no Fed speakers until Chair Jerome Powell’s post-decision press conference Wednesday afternoon.'' 

The sentiment sent the yield on US Treasuries higher with the 10-year yield traded over the 3% milestone level today, the highest since December 2018. Similarly, the 2-year yield traded near 2.75% today, the highest since April 22 and nearing that day’s high near 2.78%. 

''This uptrend is likely to continue as US inflation runs hot and the Fed continues its aggressive tightening cycle Of note, the 2-year interest rate differentials are moving back in the dollar’s favour after a brief corrective phase last week. In particular, the spreads with Japan (276 bp) and the UK (112 bp) continue to make new cycle highs, while the spread with Germany (248 bp) is lagging a bit.  All three should continue to rise,'' analysts at Brown Brothers Harriman said. 

Meanwhile, analysts at TD Securities said that they think USD/CAD is a tricky proposition given that the Fed has scope for a much higher terminal rate relative to the Bank of Canada. ''We prefer to fade a 1.24/28 range in USD/CAD until proven otherwise.''