USD/CAD Slips Amid Rate Cut Expectations and Weakening Oil Prices

The US dollar faced a broad sell-off yesterday, triggered by a weaker-than-expected US JOLTS (Job Openings and Labor Turnover Survey) report, which helped push USD/CAD toward the 1.3500 mark. This market move was notable given that the Bank of Canada (BoC) had just cut its policy rate by 25 basis points for the third consecutive meeting, bringing the rate down to 4.25%. Despite this monetary easing, the Canadian dollar remained relatively stable, suggesting that much of the dovish outlook for the BoC had already been priced in by investors. Over the past month, the USD/CAD pair has been correcting lower, down from its peak of 1.3946 in early August. This correction has been driven by a narrowing gap in monetary policy expectations between the BoC and the US Federal Reserve. While the BoC has led the current rate-cutting cycle, market sentiment now suggests that the Federal Reserve may soon follow, with the possibility of rate cuts as early as this month. That said, based on short-term yield spreads, USD/CAD may have overshot to the downside when it briefly hit 1.3441 at the end of August.

The Canadian bond market has already priced in a significant number of rate cuts by the BoC over the coming year, with the market currently anticipating up to five more 25 basis point cuts by mid-2025. This would bring the BoC’s policy rate closer to its neutral range of 2.25% to 3.25%. As a result, it may be challenging for the Canadian dollar to weaken further on dovish surprises alone unless the BoC adopts a more aggressive stance, such as implementing a 50-basis point cut. However, in its latest update, the BoC maintained a cautious yet dovish tone, signalling that further rate cuts remain on the table in the months ahead. BoC Governor Tiff Macklem emphasized that the central bank is exploring multiple scenarios, including the possibility of more substantial 50 basis point cuts if economic conditions deteriorate significantly. He acknowledged that if the economic and inflation outlook worsens more than expected, “it could be appropriate to take a bigger step, something larger than 25 basis points.”

The BoC’s approach mirrors concerns that are also evident within the US Federal Reserve, particularly regarding signs of a weakening labour market. Recent employment data in Canada has shown a slowdown in job growth, adding to the central bank’s concerns. Additionally, the BoC remains cautious about allowing the economy to slow too much or inflation to fall too far below its target. With inflation already nearing the BoC’s target range, the case for a more cautious approach to rate cuts is reinforced. Meanwhile, the continued decline in oil prices, which have recently fallen toward USD 70 per barrel, is also weighing on the Canadian dollar, particularly against other non-USD G10 currencies. This decline in energy prices is critical for Canada’s economy, given the country’s heavy reliance on its oil and energy exports. Consequently, the Canadian dollar may remain under pressure, especially if oil prices continue to weaken alongside further monetary easing from the BoC.

In summary, the recent moves in USD/CAD reflect both domestic and global factors, including shifts in monetary policy expectations, economic data, and commodity price trends. While the BoC continues to signal dovishness, the market has already priced in much of this outlook, meaning further Canadian dollar weakness may require more aggressive policy moves or a significant deterioration in economic conditions. Additionally, the potential for the Federal Reserve to begin its own rate-cutting cycle could further complicate the outlook for USD/CAD, as shifts in US monetary policy would likely have a broader impact on global currency markets.

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