The USD/CAD is trading near five-month lows as holiday-thinned markets limit volatility. The Canadian Dollar gains support from a policy divergence between the Bank of Canada (BoC) and the Federal Reserve (Fed), with the BoC expected to hold rates through 2026.
Despite the US Dollar (USD) trading strongly, the Canadian Dollar (CAD) holds modest gains. Currently, USD/CAD is around 1.3675, its lowest since July.
Canadian and US Economies
On Tuesday, Canada’s GDP data revealed a 0.3% monthly contraction in October, aligning with expectations. The US economy’s preliminary third-quarter GDP outperformed predictions, showing a 4.3% annualised growth.
The BoC’s decision to maintain a 2.25% policy rate, with an end to its easing cycle, contrasts with the Fed’s anticipated gradual easing. Markets expect the BoC to hold rates steady until 2026, while the Fed’s future rate cuts are uncertain.
Key factors influencing the CAD include the BoC’s interest rates, oil prices, economic health, inflation, and trade balance. High oil prices and positive economic indicators generally support the CAD, attracting foreign investment.
Higher inflation may lead to raised interest rates, benefiting the CAD. Economic strength can attract foreign investors and lead to a stronger Canadian Dollar.
With USD/CAD testing five-month lows near 1.3675, the main driver remains the widening policy gap between the Bank of Canada and the Federal Reserve. Holiday-thinned markets are keeping volatility low for now, but we see this as an opportunity to position for early 2026. The core view is that the BoC will hold rates firm while the Fed prepares to cut.
Canadian Dollar and Energy Markets
This divergence is backed by recent data that we are watching closely. November’s Canadian inflation report, for instance, came in at a stubborn 2.9% year-over-year, giving the BoC every reason to maintain its 2.25% policy rate. In contrast, markets are pricing in a greater than 65% chance of a Fed rate cut by their March 2026 meeting, according to the CME FedWatch tool.
The strength in the Canadian dollar is also getting a significant boost from energy markets. WTI crude oil prices have climbed back above $82 per barrel, supported by stronger winter demand forecasts and continued OPEC+ supply discipline. As oil is Canada’s largest export, this price strength provides a fundamental tailwind for the loonie.
For derivative traders, the current low implied volatility in the quiet holiday period presents a chance to buy options relatively cheaply. We believe purchasing Canadian dollar call options or US dollar put options with expirations in late Q1 2026 could be an effective way to play this trend. These positions would benefit if the pair continues its downward move as trading volumes return in January.
However, we must remain aware of the risks to this view. Recent data showed the Canadian economy contracted in October 2025, while US Q3 GDP was a robust 4.3%, suggesting the US economy is on much stronger footing. Furthermore, speculative positioning data shows that long Canadian dollar trades are becoming crowded, which could lead to a sharp reversal if market sentiment shifts.
