The Canadian dollar (CAD) gained modestly against the US dollar (USD) on Wednesday, although the greenback traded firmer amid limited volatility as the market went into holiday mode. At the time of writing, USD/CAD is trading around 1.3675, close to its lowest level since July 25.
Gross domestic product (GDP) data released on Tuesday did little to change sentiment around the USD/CAD. Canada’s economy contracted 0.3% MoM in October, in line with forecasts and a contrast to a 0.2% gain in the previous month. Meanwhile, preliminary estimates of third-quarter GDP showed the US economy grew at a strong annual pace of 4.3%, beating both the prior estimate of 3.8% and the market expectation of 3.3%.
The Loonie is based on growing policy differences between the Bank of Canada (BoC) and the Federal Reserve (Fed). The BoC kept its policy rate unchanged at 2.25% at its December meeting, signaling comfort with its current policy stance, saying current settings are appropriate to support the economy while keeping inflation close to the 2% target.
After a cumulative 100 basis points (bps) of rate cuts since the beginning of the year, the market has largely interpreted this decision as the end of the BoC’s easing cycle. In the minutes of their latest meeting, Governing Council members acknowledged that uncertainty remains and discussed whether the next policy move would be an increase or a cut. Although officials agreed that the current policy rate is “about right” now, they stressed that it is difficult to predict the timing and direction of the next adjustment.
That said, the base-case outlook for the BoC is to keep the policy rate around 2.25% for most of the next year, with some upside risk that the next step could be a hike in the second half of 2026.
In contrast, the Fed appears to be moving on a more gradual easing path. The market expects further monetary policy easing next year after the Fed cut rates by a total of 75 bps this year. However, policymakers are divided on the need for additional cuts, citing differing views on inflation and labor market conditions.
However, the market widely expects the Fed to keep rates steady in January, with CME FedWatch pricing in only a 13% chance of a cut, while still expecting two rate cuts by the end of the year.
Canadian Dollar FAQ
The key factors driving the Canadian dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of oil, Canada’s largest export, the health of its economy, inflation, and the trade balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or looking for safer assets (risk-free) – with risk-on CAD being positive. As its largest trading partner, the health of the US economy is also a major factor influencing the Canadian dollar.
The Bank of Canada (BoC) has a significant influence on the Canadian dollar, setting the level of interest rates that banks can lend to each other. This affects the level of interest rates for everyone. The main goal of the BOC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively high interest rates are positive for CAD. The Bank of Canada may also use quantitative easing and tightening to influence credit conditions, with the former being CAD-negative and the latter CAD-positive.
The price of oil is a major factor influencing the value of the Canadian dollar. Petroleum is Canada’s largest export, so the price of oil has an immediate impact on the CAD value. Generally, if the price of oil increases, the CAD also increases, as aggregate demand for the currency increases. The situation is opposite if the price of oil falls. Higher oil prices also increase the likelihood of a positive trade balance, which is also supportive for the CAD.
While inflation was traditionally thought of as a negative factor for a currency as it reduces the value of money, in modern times with the relaxation of cross-border capital controls the opposite has actually become the case. High inflation prompts central banks to raise interest rates, which attracts more capital inflows from global investors looking for an attractive place to keep their money. This increases the demand for the local currency, which in the case of Canada is the Canadian dollar.
Macroeconomic data releases reveal the health of the economy and can have an impact on the Canadian dollar. Indicators such as GDP, manufacturing and services PMIs, employment and consumer sentiment surveys can influence the direction of the CAD. A strong economy is good for the Canadian dollar. This not only attracts more foreign investment but it may encourage the Bank of Canada to raise interest rates, thereby strengthening the currency. However, if economic data is weak, the CAD is likely to fall.
