USD/CAD dropped to a five-month low of 1.3675 on Wednesday, as the US Dollar weakened. This change is due to expectations of two Federal Reserve rate cuts in 2026. Meanwhile, Canada’s economy showed improvement, growing 0.1% in November after a 0.3% decline in October. The USD/CAD decline continued for a third straight session, facing pressure during Asian trading hours. Calls for lower borrowing costs added to the dovish sentiment, despite the rapid US economic growth in the third quarter.

Federal Reserve Interest Rate Overview

Recent White House comments indicate that the Federal Reserve is not reducing interest rates quickly enough. Early US GDP data revealed a growth of 4.3% in the third quarter, higher than the expected 3.3%. The US core PCE Price Index rose by 2.9%, and the GDP Price Index went up by 3.7%, exceeding predictions. Analysts warn that strong GDP figures might not indicate overall economic health since this growth was mostly driven by healthcare spending and inventory reductions. Canada’s GDP estimate showed a slight 0.1% increase in November, easing concerns about growth. The Bank of Canada kept the overnight rate at 2.25%, indicating a pause in cuts, which supports the Canadian Dollar. With USD/CAD falling below the key level of 1.3700, the trend appears to favor a stronger Canadian dollar heading into early 2026. The market is increasingly considering a divergence in policies, with the Federal Reserve likely to cut rates while the Bank of Canada stays firm. In this context, selling rallies in the US dollar seems to be the preferred strategy.

Outlook for USD/CAD and Trading Strategies

We think the market is right to look beyond the strong US Q3 GDP figure and focus on potential future weaknesses. The cooling labor market in the US, with job openings dropping below 9 million for the first time in over a year at the end of 2025, supports the idea that the Fed may ease its policies. This narrative is strong enough to overshadow the headline growth numbers, which rely on less sustainable elements. On the flip side, the Canadian economy is displaying resilience, avoiding a technical recession with its modest growth in November. Coupled with stable oil prices, particularly Western Texas Intermediate, which has remained above $75 a barrel during the fourth quarter, the outlook for the Canadian dollar appears strong. The Bank of Canada’s current rate of 2.25% now looks appealing. For derivative traders, this outlook suggests that buying USD/CAD put options is a smart strategy to bet on further declines. We recommend looking at options expiring in the first quarter of 2026, aiming for strikes around the 1.3550 mark. This approach offers a defined-risk method to profit if the US dollar continues to weaken against the Canadian dollar. Given the low trading volume during the holiday season, caution is warranted regarding sudden price swings. A more conservative strategy could be a bear put spread, where you buy a higher-strike put and sell a lower-strike one. This limits your initial costs and potential profits while protecting against abrupt market reversals. Looking ahead, we need to closely watch the upcoming US employment and inflation reports in January. If these figures point to a continued slowdown in the US economy, it will strengthen expectations for Fed rate cuts and probably push USD/CAD lower. Any signs of persistent inflation in Canada would further support our outlook. Create your live VT Markets account and start trading now.

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