TORONTO (Reuters) - The Canadian dollar rebounded to close higher versus the U.S. dollar on Wednesday, with the greenback falling after a statement from the U.S. Federal Reserve convinced the market to pare back calls for aggressive U.S. rate hikes.
Canadian bond prices ended mostly flat across the curve and were unable to build significantly on gains recorded early this week as the Fed warned of elevated risks of inflation as it decided to leave its federal funds rate steady.
The Canadian dollar closed at C$1.0107 to the U.S. dollar, or 98.94 U.S. cents, up from C$1.0115 to the U.S. dollar, or 98.86 U.S. cents, at Tuesday's close.
The higher close for the Canadian currency, its third straight, came after the Fed's statement showed it was not concerned enough about inflation to trigger rate hikes, which ultimately undercut the U.S. dollar.
That opened the door for the Canadian currency to recoup earlier losses and rally to a session high of C$1.0088 to the U.S. dollar, or 99.13 U.S. cents, its highest level in three weeks, before giving back some of the gains.
"It's mainly because of the general U.S. dollar weakness following the Fed statement," said Matthew Strauss, senior currency strategist at RBC Capital Markets.
"It seems at least that the market is interpreting the statement as less hawkish than what they would have liked to see given the flurry of inflation concerns expressed by Fed officials during the last few weeks."
While the U.S. central bank expressed worries about upside risks to inflation, it also said it expects price pressures to moderate this year. Those comments were enough to convince the market to pare back expectations of interest rate increases.
Earlier this month, the Bank of Canada joined the chorus of most other major central banks when it cited the risk of rising inflation as the reason behind its decision to leave interest rates steady despite unanimous forecasts that it would cut rates.
Canadian bond prices finished a touch higher across the curve as the market scaled back its expectations for a U.S. rate hike after the Fed's statement came in less hawkish than had been anticipated.
Interest rate futures show traders now see a 33 percent chance of the Fed raising its key rate in August, which is down from 48 percent before the Fed's rate decision.
"The bias is certainly a tightening bias but only just slightly, and there is no firm commitments to increase rates any time soon," said Carlos Leitao, chief economist at Laurentian Bank of Canada in Montreal. "So I don't think markets are quite sure what song to sing."
The two-year bond rose 2 Canadian cents to C$100.97 to yield 3.226 percent. The 10-year bond ended up 7 Canadian cents at C$102.21 to yield 3.706 percent.
The yield spread between the two-year and 10-year bond was 48.0 basis points, up from 47.8 at the previous close.
The 30-year bond added 4 Canadian cents to C$116.02 for a yield of 4.054 percent. In the United States, the 30-year Treasury yielded 4.648 percent.
The three-month when-issued T-bill yielded 2.68 percent, down from 2.72 percent at the previous close.
Editing by Peter Galloway