The USD/CAD currency pair has been falling for four days in a row. This is mainly because the Canadian Dollar has strengthened after a rebound in Canada’s Q3 GDP. Currently, the pair is trading around 1.3984, reflecting ongoing weakness in the USD. In the third quarter, Canada’s economy grew, with real GDP climbing 0.6%. The annualized growth rate jumped to 2.6%, surpassing expectations. This growth was mainly boosted by trade, as exports increased by 0.2% while imports dropped by 2.2%.

Monetary Policy and Interest Rates

The Bank of Canada (BoC) is likely to keep its interest rate steady at its December meeting after lowering it to 2.25% in October. On the other hand, the Federal Reserve is considering a rate cut next month, with an 85% chance of reducing it by 25 basis points. The BoC manages monetary policy to ensure price stability. It raises interest rates to strengthen the CAD or uses tools like quantitative easing to weaken it. Conversely, quantitative tightening strengthens the CAD as the BoC stops buying assets. The differing policies of the BoC and the Federal Reserve are expected to keep the USD under pressure, leading to a bearish outlook for USD/CAD.

Divergence in Central Bank Policy

The gap between central bank policies is a key factor driving the USD/CAD pair. Canada’s economy is showing unexpected strength with its annualized 2.6% growth in Q3, allowing the BoC to keep interest rates steady. This is a stark contrast to the U.S., where weak data is pushing the Federal Reserve toward a rate cut. Recent data supports this view. The latest U.S. Core PCE Price Index, which the Fed favors for measuring inflation, came in slightly below target at an annualized 2.1%. Additionally, initial jobless claims rose to their highest level in three months. These factors reinforce the market’s expectation of an 85% chance of a Fed rate cut at the December 10th meeting. For traders focusing on derivatives, this situation presents opportunities to profit from a falling or capped USD/CAD. Strategies like selling call options or using bear call spreads above the 1.4050 level could generate income, based on the belief that any upward moves will be limited. For those who strongly believe in a decline, buying put options offers direct exposure to potential further drops. Looking back, a similar scenario occurred during 2017-2018. At that time, the Bank of Canada started raising rates before the Fed, leading to a sustained decrease in the USD/CAD exchange rate. History shows that when these policies diverge, the resulting trend can gain significant momentum. However, we should also examine the details of Canada’s recent GDP report. The growth was driven mainly by a decrease in imports rather than strong domestic demand, which has actually weakened. If Canadian consumer spending continues to decline into the new year, it may force the Bank of Canada to reevaluate its neutral stance. Create your live VT Markets account and start trading now.

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