The BOC is widely expected to keep rates unchanged ahead of the FOMC’s meeting on Wednesday. This is somewhat unusual, as the two central banks often move in tandem, given the interconnectivity between the two economies. The shift in the interest rate gap could support the CAD, but signals from the BOC could also drag CAD/USD lower.
Policy between the Fed and the BOC is expected to diverge next year. Markets are betting on the Fed easing by around 100 bps through 2026, while economists argue that the BOC’s easing cycle has ended. Canada’s central bank started easing and continued to do so for longer than the Fed. This has left the CAD relatively weaker, but the upcoming meeting might signal a reversal of the trend.
Has the CAD Touched Bottom?
The Canadian dollar has strengthened substantially since the start of the month, rising 1.4% against the greenback over the last couple of weeks. Part of that can be attributed to what’s going on south of the border. Markets shifted to price in more easing from the Fed after it appeared that US President Donald Trump had settled on a more dovish replacement for Fed Chair Jerome Powell.
But the situation in Canada has also been moving the currency. After the last meeting, the BOC suggested it was near the end of its extensive easing cycle. The bank had been worried about the economic impact of the ongoing trade war with the US. However, over time, businesses get used to the new normal, and the situation appears to be stabilizing. After signing a series of trade deals with other countries, it seems it’s just a matter of time before the US agrees to reduce tariffs with Canada.
Several Positive Surprises
Canada’s Q3 GDP grew faster than anticipated, and the last three jobs reports have come in ahead of consensus. This suggests that economists’ outlook for the Canadian economy is undershooting reality. So, even though the inflation rate isn’t threatening to fall below target any time soon, the BOC might shift to a more neutral stance and wait to see what happens with the economy through the winter.
The BOC might also be adjusting its views about the impact of tariffs. Initially, Governor Tiff Macklem warned that the slowing economy was a significant impact of the trade war. Now that the economy has settled, the bank’s focus could shift to price effects. The tariffs are seen as a supply shock to the economy, so lowering interest rates into accommodative territory might risk increasing inflation above target.
Where Will the CAD Go After the Meeting?
The market’s response to the BOC’s meeting might be a little delayed as traders look to view it in the context of the Fed’s decision. A prolonged easing cycle by the Fed would also have stimulatory effects on the Canadian economy. That could leave the BOC more inclined towards hawkishness. Depending on what Macklem communicates about the outlook for policy, the Fed decision could reverse some of the price action or enhance it.
The market is currently pricing in practically nil odds of a rate cut next year. This means that hints at dovishness from the BOC would likely weaken the CAD. On the other hand, if Macklem expresses more direct concern about inflation, the loonie could get a boost.
