The Bank of Canada is expected to lower interest rates by 25 basis points today. This matches the market’s expectation, reflected in the CAD Overnight Index Swap (OIS) curve pricing at 21 basis points. The decision comes amid ongoing trade risks, heightened by recent tensions between the US and Canada, which overshadow stronger employment and inflation data from September.

Potential for More Rate Cuts

Given the worsening trade environment, further rate cuts might be needed. Currently, the market anticipates a total easing of 35 basis points by January. However, there could be calls for larger cuts if conditions worsen. Canada’s real policy rate is higher than in previous periods of similarly high unemployment at 7.1%, suggesting that more easing measures should be considered. Despite negative trade news, the Canadian dollar has remained strong because it was already undervalued compared to its short-term fair value. Now, expectations indicate USD/CAD might rise to 1.41 in the short term, although the year-end prediction stays at 1.38 if trends hold. With the Bank of Canada expected to cut rates by 25 basis points today, the market has almost fully anticipated this move. This is noteworthy given that September’s inflation unexpectedly rose to 2.3%, showing the bank’s greater concern about trade issues. The White House’s recent announcement to review tariffs on Canadian lumber and dairy underscores the rising risks. The real opportunity for traders lies in the bank’s forward guidance, likely suggesting more easing will follow. Currently, the market is only factoring in about 15 basis points of cuts over the next six months, which seems too low given the risks. With unemployment at 7.1%, historical data from 2015-2016 suggests that a more aggressive approach to easing may be necessary during times of high trade risk.

Opportunities in the Options Market

This situation creates opportunities in the options market, especially buying USD/CAD calls with expirations in January 2026 to prepare for another rate cut. Implied volatility on three-month USD/CAD options has risen to 7.8% from early October lows, indicating that traders are beginning to factor in more uncertainty. A dovish surprise today could further increase volatility, making long-volatility positions appealing. While many traders are already short on the loonie, a decidedly dovish Bank of Canada could push USD/CAD higher towards the 1.41 level. This perspective is backed by the differing policies of central banks, as recent Federal Reserve minutes suggest a steady approach into early 2026. Thus, even with a year-end target of 1.38, the most likely trend in the coming weeks seems to be upward. Create your live VT Markets account and start trading now.

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