The Canadian economy is currently under strain, with the Toronto housing market experiencing a noticeable downturn. This decline could lead to pressure as the sales of pre-built homes and condos decrease. Additionally, future US-Canada trade negotiations are creating uncertainty.
Next summer’s renegotiation of the USMCA agreement could bring challenges, with possible tariffs of 15% on Canadian and Mexican goods. Current economic indicators show strong retail sales, but weak job reports and reduced business investment. Meanwhile, potential court rulings that invalidate tariffs may benefit Canada if upheld, though complications from potential new tariffs remain a possibility.
Exchange Rates and Their Impact
A negotiated trade deal may not offer the same benefits as previous arrangements. Exchange rates have been stable between 1.37-1.39 since August, influenced by Canadian employment data. Currently, the downtrend in Canadian currency is still apparent, with potential changes in the exchange rate if it surpasses 1.3940 towards the mid-1.40s.
A significant factor is the upcoming central bank meeting, where a rate cut is 90% priced in, with a 53 bps cut for the year anticipated. More cuts may follow to manage inflation, affecting the Canadian dollar and exchange rates. It is advisable to monitor the BOC’s direction by closely observing the 1.37-1.39 range.
We see a Bank of Canada rate cut on September 17 is almost fully priced in by the market. However, the Canadian economy’s weakness suggests this might just be the beginning of a larger cutting cycle. This outlook is creating a tense waiting game for the Canadian dollar.
The Canadian economy is showing clear signs of strain, which supports the case for more rate cuts. For instance, we saw the economy shed 15,000 jobs last month, pushing the unemployment rate up to 6.4%. This weakness is compounded by a struggling Toronto housing market, where sales dropped 18% year-over-year in August.
Beyond domestic issues, we have to watch the deep uncertainty surrounding US-Canada trade relations. The renegotiation of the USMCA agreement scheduled for next summer is a major dark cloud on the horizon. The mere threat of a 15% baseline tariff is enough to keep business investment on the sidelines for now.
Trading Strategy and Market Movements
From a trading perspective, the USD/CAD pair has been locked in a quiet range between 1.37 and 1.39 since August. This consolidation reflects the market’s indecision ahead of the central bank meetings. We are essentially waiting for a catalyst to break this deadlock.
The strategy now should focus on this 1.37-1.39 range, with the BOC and FOMC meetings on September 17 being the likely trigger for a breakout. A decisive move above 1.3940, especially if driven by a dovish BOC, would signal a strong case for buying USD calls or call spreads, targeting a move into the mid-1.40s. This reflects the possibility that the market will have to price in an additional 50 to 100 basis points of cuts over the next year.
We can look back to 2015 for a potential roadmap, when the Bank of Canada cut rates twice to deal with the oil price shock while the Federal Reserve was on a tightening path. During that period of policy divergence, we saw USD/CAD rally significantly from below 1.20 to above 1.45 over the course of about a year. A similar divergence, even a minor one, could fuel a sustained move higher in the pair.
