* Canadian dollar at C$1.2521, or 79.87 U.S. cents
* Prices of longer-term bonds higher across maturity curve
TORONTO, July 26 (Reuters) - The Canadian dollar softened against its U.S. counterpart on Wednesday despite higher oil prices, as a firmer greenback drove direction ahead of the U.S. Federal Reserve's latest policy decision.
The Canadian dollar has rallied some 10 percent since early May, mostly on the back of a weaker U.S. dollar and robust economic data that spurred the Bank of Canada to raise interest rates earlier this month. Higher oil prices also have helped.
Bond yields hit multi-year highs this week and U.S.-Canada 2-year bond yields spread have narrowed sharply since June.
At 9:28 a.m. ET (1328 GMT), the Canadian dollar CAD=D4 was trading at C$1.2521 to the greenback, or 79.87 U.S. cents, down 0.1 percent.
The currency traded between C$1.2502 and C$1.2528, slightly off the more than 14-month high of C$1.2481 reached on Tuesday.
Markets have reduced expectations for a U.S. interest rate increase in the coming months with expectations of another rate hike before the end of the year at less than 50 percent, according to Reuters polls and CME's FedWatch tool. the U.S. labor market remains healthy, weak wage growth and cooling inflation will likely keep the Fed on the sidelines. Economic growth in the United States has not picked up as previously expected either and is now seen to be modest at best this year and in 2018.
Meanwhile, currency strategists have recently noted that the traditional correlation between the Canadian currency and the price of oil, a major Canadian export, has broken down.
In Canada, gross domestic product data for May is due on Friday ECONCA .
Canadian government bond prices were higher across the maturity curve, with the two-year CA2YT=RR price up 2 Canadian cents to yield 1.315 percent and the benchmark 10-year CA10YT=RR rising 14 Canadian cents to yield 2.002 percent.
The Canada-U.S. two-year bond spread was -7.6 basis points, while the 10-year spread was -31.9 basis points.