The USD/CAD pair has continued its decline, slipping below 1.3700 and reaching its lowest point since October 2024. This drop is mainly due to a weaker US Dollar, driven by concerns about the US fiscal situation and expectations of lenient Federal Reserve policies. The US Dollar Index (DXY) has fallen to a near one-month low. This change reflects worries about a projected $4 trillion increase in the US deficit over the next ten years. Softer inflation data in the US has fueled speculation that the Federal Reserve may cut interest rates to help boost economic growth.

Canadian Dollar Strength

On the other hand, the Canadian Dollar has shown strength due to unexpectedly strong Canadian core inflation figures. This reduces the chances of an interest rate cut by the Bank of Canada, even as crude oil prices dip slightly. The Canadian Dollar is influenced by several factors, including interest rates set by the Bank of Canada, oil prices, the health of the economy, inflation, and trade balance. Generally, higher interest rates and good economic data support the CAD. Rising oil prices can improve the trade balance and strengthen the currency. Conversely, economic weakness can cause the CAD’s value to drop. With USD/CAD clearly moving below the 1.3700 mark and hitting a level not seen since October, we see not only downward pressure on the US Dollar but also a surprising strength in the loonie. There are two factors at play here: US fiscal challenges and inflation data suggest a softer approach from the Fed, while stronger Canadian inflation keeps the possibility of rate cuts from the Bank of Canada low. These trends indicate a change in sentiment. The drop in the US Dollar Index to a near one-month low shows that the market is not just reacting to inflation; it is also anticipating future stress on the balance sheet. The expected $4 trillion increase in the US deficit over the next decade raises long-term concerns about interest rates and the demand for the dollar. When inflation data weakens alongside fiscal warnings, the dollar faces additional pressure—something we saw again this week.

Central Bank Dynamics

The situation benefits Canada’s rate-setting division. The Bank of Canada isn’t necessarily adopting a hawkish stance, but it doesn’t feel as pressured to act for growth. Strong core inflation figures have ruled out immediate policy changes. While a slight drop in oil prices usually weakens the CAD, better domestic data stability is outweighing this effect. This results in a delicate positioning environment. We are in a phase where traders need clarity, precision, and agility in response to central bank shifts. Market indicators suggest traders expect the Fed to adjust rates more quickly, which affects rate spreads. As macro spreads widen against the USD, trades based on relative value for the CAD look more appealing, especially as trends improve. Recently, the correlation between commodities and currency has weakened. Therefore, oil’s modest price drop hasn’t significantly impacted the support for the loonie as earlier trends would suggest. The CAD’s lack of a strong reaction to falling oil prices indicates that traders are focused on how central banks differ, and currently, Canada has the advantage due to its inflation profile. As we move forward, the likelihood of volatility increases around policy announcements and key economic reports. It’s crucial for traders not only to hedge against directional changes but also to manage the risks associated with volatility shifts. With expectations for US rate cuts gaining momentum, gamma positioning will likely become more aggressive. Upcoming data on CPI, employment, and central bank comments will be very important. We have observed that options markets are biased toward deeper downside strikes in the pair, showing trader positioning beyond just sentiment, especially for longer durations. This asymmetry suggests that the broader market views these levels as significant, possibly marking a recalibration point. It emphasizes the need for hedging strategies to consider not just the short-term but also longer calendar spreads or protection against volatility. Maintaining flexibility across different timeframes has become more beneficial than sticking to fixed delta positions. With rising expectations built into futures pricing, there’s now a stronger case for adjusting implied volatility assumptions. If the economic divergence continues, the risk of price adjustments may increase, especially as traders shift from predicting to executing strategies. Create your live VT Markets account and start trading now.

here to set up a live account on VT Markets now