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CAD is significantly undervalued.
The Canadian dollar is poised to recover after months of underperformance, according to economists at Canada's Desjardins, who say the worst is likely behind for the loonie.
In a new report titled "The Worst Is Over for the Loonie," Desjardins's Jimmy Jean, Vice-President and Chief Economist, and Mirza Shaheryar Baig, FX Strategist, upgraded its outlook for the Canadian dollar.
They cite reduced rate cut risks, supportive valuation metrics, and easing U.S. dollar dominance.
The authors stop short of saying tariff risks have fully abated for the CAD, but "the market is factoring in only a short period of tariffs, particularly since the Trump administration has made many U-turns."
Regarding the Bank of Canada, analysts note the central bank has taken a more cautious stance on further monetary easing after front-loading its rate cuts.
"There can be no doubt about the central bank’s commitment to low inflation," Governor Tiff Macklem recently said, highlighting concerns that the weak Canadian dollar may be contributing to inflationary pressures.
In contrast, the U.S. Federal Reserve has adopted a more dovish tone. "The Fed is more concerned about the persistence of a growth shock than inflation," Jean and Baig noted, adding that this divergence opens the door for a narrowing in U.S.-Canada yield spreads - traditionally a tailwind for the CAD.
Loonie Undervalued, Flows May Return
Desjardins highlighted that the loonie is significantly undervalued on a trade-weighted basis, with the real effective exchange rate at a 10-year low. “This relative cheapness should help Canadian exporters in their effort to find new markets outside of North America,” the authors wrote.
Moreover, Desjardins sees scope for domestic capital to flow back into Canadian assets, particularly if upcoming elections result in reforms to boost productivity and unlock economic growth. "Improving investor sentiment could reverse decades of capital outflows from Canadian households and institutional investors."
Election Unlikely to Shake FX Markets
With elections set for April 28, both the ruling Liberal Party and the opposition Conservatives remain tied in polls. "We think the Canadian dollar will not be significantly impacted by the election outcome," Desjardins said. Both parties are aligned on key economic reforms, including mineral investment and reducing internal trade barriers.
Risks Remain
Despite the upbeat tone, Desjardins acknowledged downside risks. "If the tariff hikes prove more durable or more punitive, CAD may weaken further," the report cautioned, pointing to the upcoming U.S. reciprocal tariff announcements on April 2.
Still, the overall message from Desjardins is clear: “The worst is over for the loonie,” the report declared.
"We are no longer forecasting USD/CAD to rise to 1.48 this year," says Jean. "We now see USD/CAD holding in a 1.41–1.45 range over the next three months and expect CAD to appreciate over the medium term."