The Canadian dollar experienced significant declines in December of last year, as economic data pointed to a weakening economy and overstretched consumers. In contrast, the US economy and consumers seemed to be adjusting well to higher interest rates, evidenced by a steady stream of strong economic data. Based on this, analysts had expected the Bank of Canada to begin the cycle of interest rate cuts sooner than the Federal Reserve. However, over the last month, initial indications of a slowing US economy have begun to emerge. Tuesday’s US ISM Services Purchasing Managers Index (PMI) and US Factory Orders were the latest examples of softer than expected economic news from the US. This has led market watchers to speculate that the Fed, like the Bank of Canada, may also need to cut rates sooner than initially anticipated.
Both central banks are trying to balance the risk of keeping interest rates high for too long, acting as an anchor on economic growth, versus cutting interest rates too soon and risking inflation rising above the targeted 2% goal. Increasingly, it appears that the paths forward for both the BoC and the Fed are converging. This could help explain why the US dollar and Canadian dollar exchange rate has been trading in such a tight range over the last month. The Bank of Canada is widely expected to hold rates at 5% at its meeting on Wednesday, but there is a growing belief among economists that the BoC may adopt a more dovish tone (softer stance on inflation) in its accompanying statement. Also on Wednesday, the US ADP employment numbers are expected to be released. Any indication that the BoC and the Fed may diverge from their similar path of interest rate cuts could push the USD/CAD pair out of its current trading range. For example, if the BoC is not as dovish or does not hint at cuts in its statement, the Canadian dollar could consolidate and move off its multi-month lows (CAD/USD highs).
The Canadian dollar is currently trading at 1.3539 CAD against the US Dollar.
