Canadian Dollar Faces Mounting Pressure Amid U.S. Economic Strength and Rising Yield Gaps

The Canadian dollar (CAD) has recently come under pressure, sliding to a nearly three-month low against the U.S. dollar (USD). This depreciation is primarily driven by a widening gap between Canadian and U.S. short-term interest rates, a disparity that has reached levels distinctly favouring the USD. This yield gap reflects a broader divergence in economic momentum between Canada and the U.S., contributing to the CAD's recent weakening.

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 Source: TradingViewIn the United States, economic performance remains robust. Key economic indicators reveal a strong labour market, with private employment levels hitting their highest point in a year. U.S. GDP growth is also impressive; for Q3 2024, the annualized growth rate hovers close to 3%, underscoring a resilient economy. By contrast, Canada’s economic growth has been subdued, and the Bank of Canada (BoC) projects Canadian GDP growth at only half of the U.S. pace for the same quarter. Statistics Canada data for August and September also suggest that Canada’s growth may be lagging, with estimates pointing to a mere 1% annualized increase. While some of this stagnation is expected to be temporary, the BoC forecasts a modest recovery, projecting Canadian growth to near 2% in the coming months. However, the pace of economic expansion could slow further as the strong boost from immigration—an important factor in Canada’s recent growth—begins to moderate.

The BoC is thus navigating a complex economic landscape. Its focus may increasingly pivot toward inflation, particularly as wage growth and domestic price pressures continue to shape monetary policy. For traders watching the CAD, the BoC’s upcoming December meeting will be a critical event. Many market participants are weighing the potential for a 50-basis-point rate cut, an action that could place even more downward pressure on the CAD. If the BoC adopts a dovish tone, the USD/CAD exchange rate could approach the psychologically significant level of 1.40, especially amid potential shifts in U.S. economic policy around the 2024 elections.

The outlook for the Canadian dollar, therefore, is marked by considerable uncertainty. As it contends with both internal economic constraints and the external influence of a strong U.S. dollar, the CAD’s trajectory over the next several months will depend on the BoC’s monetary strategy, economic recovery signals from Canada, and the broader macroeconomic trends shaping North American markets.

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