The Bank of Canada is close to ending the cutting cycle. Image: BoC Governor Macklem. Image © Bank of Canada, Reproduced Under CC Licensing.
The Canadian Dollar is expected to maintain its upward trajectory against the U.S. Dollar on narrowing interest rate differentials.
This is according to Rabobank, the Dutch-based international investment bank and lender.
Driving the narrowing in Canadian and U.S. interest rate differentials is the Federal Reserve’s rate-cutting cycle, which is tipped to gather pace in 2026, while the Bank of Canada (BoC) is likely to complete its own easing path earlier, reaching a terminal rate of 2.50%.
The U.S.-Canada rate differential is projected to shrink from 175 basis points today to just 75 basis points by the end of 2026.
Analysts say the compression in interest rates should mean USD/CAD trade within a range of 1.34 to 1.36 over the coming months, which is consistent with levels seen throughout 2023 and 2024.
It is also noted that despite trade tensions and the imposition of 35% tariffs by former President Donald Trump on certain Canadian goods, market reaction has been muted and implied volatility remains subdued.
"A modest tariff premium appears to have been priced back into the pair, though this is not expected to materially derail the outlook for the CAD," says Molly Schwartz, Cross-asset Macro Strategist at Rabobank.
In addition, speculative positioning on the Canadian dollar remains net short, but the size of those positions has been steadily decreasing.
Above: USD/CAD (top) and the differential between U.S. two-year bond yields and those of Canada.
Options markets show a bias toward CAD strength, with Schwartz noting that investors are favouring downside protection in USD/CAD.
Volatility across the curve has dropped to its lowest levels since October 2024, and the one-month implied volatility on USD/CAD currently stands below 5%.
While Schwartz acknowledges that August is typically a weak month for CAD seasonally, she says this pattern is likely to be overridden by more fundamental rate dynamics.
Rabobank expects one final 25 basis point cut from the BoC in October, but "the risk now leans toward no further cuts at all."