By Michael O’Neill
The Canadian dollar heads into the heart of summer caught between two competing forces. On one side sits a Bank of Canada that appears content to stay on the sidelines after an aggressive easing cycle. On the other is a Federal Reserve that has turned noticeably more cautious about declaring victory over inflation. Throw in lingering geopolitical risks, with the usual dose of Trump-inspired headlines, and it is tempting to conclude that the Canadian dollar bus is heading for a cliff.
That may be too pessimistic.
The Bank of Canada is universally expected to keep its benchmark rate unchanged at 2.25%. Inflation is not an issue, at least as far as BoC metrics go. CPI-trim is 2.0% and CPI-median is 2.1%, right in the middle of its mandated 1-3% range.
The latest BoC surveys, the Business Outlook Survey and the Consumer Expectations Survey, painted a gloomy picture of the economy. However, it’s also worth remembering that these surveys were taken when oil prices were surging and every Middle East headline seemed to point toward a wider conflict.
The data is stale. In today’s environment, it is meaningless.
It’s Complicated
South of the border, the Fed presents a more complicated picture.
The June 17 FOMC minutes revealed a more nuanced picture than Chair Kevin Warsh’s post-meeting press conference suggested. Markets came away believing the Fed had pivoted decisively toward another rate hike. The minutes say, “not so fast.”
The committee did scrap its easing bias, removing language that implied rate cuts remained the default option and replacing it with a renewed commitment to price stability. That is undoubtedly hawkish. But abandoning a bias toward cuts is not the same as embracing a bias toward hikes.
Beneath the unanimous 12-0 vote, policymakers remained divided. Roughly half believed interest rates should finish the year around current levels or slightly lower, while the other half favoured higher rates.
Even so, the centre of gravity has shifted. A rate hike is no longer a remote risk discussed only in the footnotes. Several officials questioned whether policy is sufficiently restrictive, putting another increase firmly back on the table if inflation refuses to cooperate. And Trump just stirred the inflation pot.
US-Iran MOU, RIP
Inflation remains the Fed’s driving force and the renewed Iran and US hostilities may be the tipping point. Trump told reporters at the NATO Summit in Turkey that the memorandum of understanding (MOU) between the US and Iran is over, diplomatically calling Iranian authorities “sick and scum.” Furthermore, he said that he may renew the Iranian blockade. The odds of a more protracted conflict keeping the Strait of Hormuz closed soared with Trump’s words and actions.
Meanwhile, the latest round of US and Iran hostilities has roiled stock markets and underpinned the US dollar, setting the stage for a stormy summer.
Pushed and Pulled
The Canadian dollar remains caught between two powerful but opposing forces. Rising oil prices are normally good news for the loonie, improving Canada’s terms of trade and boosting export revenues. The latest crude rally was enough to push USDCAD below 1.4200, but that move may prove short-lived.
The same geopolitical tensions driving oil higher are also fuelling demand for safe-haven US dollars. Investors have responded by buying Treasuries, lifting US yields and reducing their appetite for risk. Historically, those flows tend to overwhelm the positive impact of higher oil prices on the Canadian dollar.
Trade uncertainty isn’t helping either. The decision to leave CUSMA subject to annual reviews instead of extending the agreement keeps another cloud hanging over Canadian exporters.
The Bank of Canada appears firmly on hold and Warsh is driving the bus, leaving him to dictate the Canadian dollar’s direction. As long as US interest rates remain higher for longer and investors continue treating the greenback as the world’s preferred safe haven, sustained Canadian dollar gains are likely to remain elusive.
Elevated crude prices should act as a drag on USDCAD gains, but bullish technicals and interest rate differentials should ensure it is well supported in the 1.4100 area.
It may be Tiff’s bus, but Warsh is behind the wheel.
