The Bank of Canada (BoC) is taking a cautious stance on the economy due to changes in U.S. trade policies. They believe that while interest rates can’t be lowered anymore, inflation is expected to stay within target. After the BoC’s recent meeting, term yields went up a bit, which helped the Canadian dollar (CAD). However, those gains quickly faded because of actions from the U.S. Federal Reserve (FOMC). Since spreads didn’t improve after both central bank decisions, the CAD could continue to drift.

Currency Movements and Risks

The CAD briefly fell below 1.39, but later recovered to the mid-1.39s. There is now a risk that it could be pushed towards 1.40. If the U.S. dollar (USD) rises past the 1.3965 mark, it might reach 1.4025 by the end of the week. This analysis comes from the FXStreet Insights Team, drawing insights from market experts as well as internal and external analytics. The Bank of Canada has made it clear that they won’t cut interest rates any further, believing that monetary policy has done all it can for now. Their outlook on the economy is not very positive, as seen in the modest 0.8% annual GDP growth for the third quarter. The key issue is the ongoing changes in U.S. trade policies that are causing structural shifts in the economy. Even though the BoC has paused on rate cuts, any strength in the Canadian dollar was quickly undone due to the U.S. Federal Reserve’s cautious approach. This has kept the gap in bond yields between Canada and the U.S. from widening in Canada’s favor. Consequently, the USD/CAD exchange rate has climbed back toward the mid-1.39s.

Inflation and Market Strategies

Canadian inflation has remained steady at 2.1% as of last month, and the central bank has little reason to make any changes unless there are significant new developments. This puts the currency at risk from outside influences, especially unresolved trade disputes related to the USMCA, which create uncertainty for exporters. This uncertainty is likely a major reason the CAD is having trouble gaining strength. For traders, this means there’s a risk of the currency moving back toward the 1.40 area due to technical factors. Buying USD/CAD call options with strikes around 1.40 or just above could be a good strategy for a potential breakout in the next few weeks. One-month implied volatility has risen to 7.5%, suggesting that the options market expects more movement in currency values. In the past, we observed similar trends during the economic uncertainty of early 2020, when USD/CAD went significantly above 1.40. While we don’t expect that level of extreme volatility again, it serves as a reminder that a solid break above 1.40 can happen quickly. This history indicates that holding bearish positions on the U.S. dollar against the CAD might become riskier if trends continue as they are. Create your live VT Markets account and start trading now.

here to set up a live account on VT Markets now