Canadian dollar in for a bumpy ride

As the countdown to central bank rate cuts continues, what’s in store for the Canadian dollar?

Economists say so far the currency has held up fairly well, as the market pulls back a bit on expectations for a Bank of Canada move and oil prices get support from OPEC+’S decision to extend production cuts. It was trading at 73.60 US cents this morning.

But that may be about to change.

Capital Economics predict that the loonie is in for a rough year, as the paths of the Bank of Canada and the Federal Reserve diverge and other headwinds threaten.

There are a few reasons for this.

Canada may have avoided a recession, but its growth is going to be weak this year, Capital predicts. Inflation has also come in cooler than expected, on track to average 2.8 per cent this quarter.

Compare that to the United States where employment growth remains strong and recent inflation readings “have surprised to the upside.”

With the economy weak and inflation cooling, Capital expects the Bank of Canada will cut its rate to 2.5 per cent by 2025 — more than investors anticipate in most developed economies.

Its forecast for the Federal Reserve, however, is closer to market expectations. Capital expects the Fed to stop cutting in 2025 once its rate reaches 3.25 to 3.5 per cent.

That would put the policy rate differential between Canada and the United States at its widest since the Great Financial Crisis.

Furthermore, with little risk of recession in the U.S. in the near term, there is a larger chance that the Fed could deliver even less easing than economists expect, said Ruben Gargallo Abargues, assistant economist with Capital.

All this would work against the Canadian dollar, but there’s more.

Capital’s commodities team expects that OPEC+ will begin to ease off some of their production cuts in the third quarter of this year, pushing oil prices as low as US$70 a barrel, from US$82 today.

“Although the relationship between the two has not been all that strong recently, we think falling oil prices will be a headwind for the Canadian dollar in both 2024 and 2025,” said Gargallo Abargues.

The final key risk on the horizon is the U.S. presidential election.

The possibility that Donald Trump could win and pull the United States out of USMCA, its trade agreement with Canada and Mexico, is an important risk to the economy — and the Canadian dollar, he said.

“All told, we think the CAD will depreciate this year as the BOC eases policy before and more aggressively than the Fed and crude oil prices fall,” Gargallo Abargues wrote.

Capital predicts the Canadian dollar will fall to 71.4 US cents by the end of this year.

“All told, we think the CAD will depreciate this year as the BOC eases policy before and more aggressively than the Fed and crude oil prices fall.”

Ruben Gargallo Abargues Assistant economist, Capital Economics