The Canadian dollar's decline to just above 70 US cents is being fueled by a robust US economy, Federal Reserve hawkishness, and a widening interest-rate gap, with implications for trade, inflation, and monetary policy.
The Canadian dollar, known as the loonie, has lingered just above 70 US cents this week, a significant drop from its high of over 74 US cents in late January.
This depreciation, which saw the currency dip below 69 US cents last year during the initial wave of protectionist trade policies under the second Trump administration, is now primarily driven by unprecedented strength in the US dollar. A resilient US economy, booming equity markets, and the Federal Reserve's hawkish stance-suggesting potential interest rate hikes to combat inflation-are all fueling the greenback's rally.
According to George Davis, chief technical strategist at RBC Capital Markets, the loonie has been caught in this broad-based move against most major global currencies. Sarah Ying, head of FX strategy at CIBC Capital Markets, adds that massive capital investments and the economic backdrop make the dollar "hot unless something breaks.
" This dynamic is creating a persistent interest-rate differential, with US rates notably higher than Canada's, making US bonds more attractive and further increasing demand for the US dollar. The Bank of Canada cut rates earlier and more aggressively than the Federal Reserve during the recent easing cycle. While swaps markets indicate a 50/50 chance of a BoC rate hike by year-end, investors anticipate one or two Fed hikes by 2026.
However, Shaun Osborne, chief currency strategist at Scotiabank, forecasts the opposite: he expects the US economy to slow and inflation to recede, particularly as US-Iran tensions ease, leading to US rate cuts rather than hikes. His scenario-higher rates in Canada and lower rates in the US-could eventually compress the rate spread and support the loonie, though timing remains uncertain.
Canada's economy has stagnated over the past year, and trade uncertainty looms as the US-Mexico-Canada Agreement (USMCA) faces an uncertain extension beyond its July 1 deadline. Interestingly, the loonie's traditional correlation with oil prices has weakened over the past decade due to declining investment in Canada's energy sector, meaning the recent surge in oil prices amid Middle East conflicts has not buoyed the currency.
With these domestic and cross-border uncertainties, Bank of Montreal senior economist Jennifer Lee believes the Bank of Canada will likely maintain its hold for the rest of the year, avoiding any tightening rhetoric in the current fragile environment. The combined effect of a strong US dollar, differential interest rates, and sluggish Canadian growth suggests the loonie will remain under pressure, reducing Canadian purchasing power for imports and raising costs for businesses that rely on US-sourced inputs, potentially hampering production and employment.
The currency's weakness does offer a silver lining for non-resource export sectors, which may gain a competitive edge despite tariff and trade turbulence
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