Insights 
VT 
The Bank of Canada is anticipated to reduce interest rates by 25 basis points today. The market expectation aligns with this view, as the CAD Overnight Index Swap (OIS) curve reflects a pricing of 21 basis points. This change is due to ongoing trade-related risks, which have grown due to recent escalations between the US and Canada. These risks overshadow the stronger employment and inflation data observed in September.
Potential for Additional Rate Cuts
Additional rate cuts might be necessary given the trade environment’s deterioration. While the market currently embeds a total of 35 basis points of easing by January, there might be suggestions for more substantial rate reductions if the situation worsens. Canada’s real policy rate exceeds levels observed when unemployment was similarly high at 7.1%, warranting consideration of further easing measures.
Despite adverse trade news, the Canadian dollar has shown resilience due to its pre-existing discounted trading against short-term fair value. Expectations now suggest a potential shift with USD/CAD possibly reaching 1.41 in the short term. However, the forecast remains for USD/CAD to end the year at 1.38, assuming current trends continue.
With the Bank of Canada poised to cut rates by 25 basis points today, we see this as almost fully priced in by the markets. This decision comes despite September’s inflation surprising to the upside at 2.3%, showing the bank is more worried about trade. The White House’s announcement last week to review tariffs on Canadian lumber and dairy is a clear sign of escalating risk.
We believe the real opportunity for traders lies in the bank’s forward guidance, which will likely keep the door open for further easing. The market is only pricing in about 15 basis points of additional cuts over the next six months, which seems too low given the circumstances. With unemployment at 7.1%, historical precedent from the 2015-2016 period suggests a more aggressive easing cycle is plausible when trade risks are this high.
Opportunities in the Options Market
This points to opportunities in the options market, particularly buying USD/CAD calls with January 2026 expiries to position for another rate cut. Implied volatility on three-month USD/CAD options has already climbed to 7.8% from its early October lows, suggesting traders are starting to price in more uncertainty. A dovish surprise today could push volatility even higher, making long-volatility positions attractive.
While building up short positions in the loonie is already a crowded trade, a decidedly dovish BoC could fuel another leg higher for USD/CAD towards the 1.41 level. This view is supported by the divergence in central bank policy, as the latest Federal Reserve minutes suggest a steady on-hold stance into early 2026. Therefore, even with the eventual year-end target of 1.38, the path of least resistance in the coming weeks appears to be upwards.
