By Michael O’Neill

The fog of war is a term used to describe military decisions being made with incomplete intelligence, contradictory reports, and mental fatigue.
And that is exactly what central bankers in the G-7 economies are dealing with. The Reserve Bank of Australia confirmed as much on Tuesday. It said about its domestic economic activity outlook that “Globally, the conflict in the Middle East poses substantial risks in both directions. Higher prices and prolonged uncertainty may cause growth to be slower.”

Bank of Canada Officials Agree

Wednesday, the BoC left the benchmark interest rate at 2.25% (to no one’s surprise), but not because they still believed January’s narrative. In January, the Bank said the current policy rate was appropriate as long as the economy evolved broadly in line with its forecast, which implied a fair degree of confidence in its outlook. Today, that language has been replaced with a more reactive stance that suggests the Bank is no longer relying on a tidy base-case scenario and will have to respond as events unfold.

Policymakers were unnerved by recent data. Fourth quarter GDP contracted by 0.6%, job gains have evaporated, and the unemployment rate has climbed to 6.7%. Exports are soft, consumer momentum is patchy, and the economy is no longer “adjusting.” Momentum is fading. Normally, that would be enough to push the Bank toward easing, but geopolitics stepped in and made a mess of everything.

Governor Tiff Macklem said it is too early to assess the full impact of the war on growth, but he made it clear that risks are mounting. Higher oil prices are already squeezing consumers, reducing disposable income and curbing spending. At the same time, financial conditions have tightened, with rising bond yields, weaker equity markets, and wider credit spreads. He also flagged broader supply risks, noting that disruptions in the Strait of Hormuz could affect commodities beyond energy, including fertilizers.

The Fed Makes Three

The FOMC couldn’t see things any better than the RBA or BOC. They left rates unchanged, as expected, but the real surprise was that the Committee appeared more unified, as only Trump apostle Stephen Miran voted to cut rates.

The highly anticipated dot plot projections shifted toward fewer cuts. In December, there was more visible support for easing as disinflation progressed. Today, that confidence has faded. The Committee now leans more firmly toward keeping policy restrictive for longer.

However, growth forecasts were revised higher, suggesting policymakers believe the US economy is more resilient than in December. Inflation projections moved the same way. Headline and core PCE are both expected at 2.7% in 2026 compared to projections of 2.4% and 2.5% for headline and core PCE in December.

So there we have it. The BoC has shifted from confident hold to uneasy hold, while the Fed leans slightly hawkish.

Can’t See the Forest Through the Trees

The Canadian dollar is drifting between weakening domestic fundamentals and a global backdrop that refuses to cooperate. The Bank of Canada’s shift from a confident hold to an uneasy one captures the dilemma. Growth is clearly losing momentum, with shrinking GDP, soft exports, and a deteriorating labour market pointing toward an economy that would normally justify lower rates. But this is not a normal cycle.

The problem is Trump. Well, actually, it is oil, but the president’s actions are driving it. The surge in crude prices tied to Middle East tensions has complicated the outlook in the worst possible way. Higher energy costs are acting as a tax on consumers, squeezing spending power while simultaneously lifting inflation risks.

At the same time, the Federal Reserve is signalling greater comfort with holding policy tight for longer, despite Trump’s demands. Growth in the US remains resilient, and inflation is proving sticky enough to keep the Fed cautious.

The Fed is not tightening but leaning against easing. The BoC, by contrast, leans toward easing but cannot act.

From the Loonie’s perspective, that divergence tilts risk modestly in favour of the US dollar due to its prospect of unchanged interest rates for longer than expected. However, with West Texas Intermediate flirting with $100.00/barrel, the Canadian dollar gets a bit of a cushion.

If oil continues to climb and the BoC remains sidelined, the Canadian dollar may find intermittent support, but unless the Canadian economy rebounds, the Loonie’s upside is limited.

The Loonie is not flying in a fog but it seems like it’s wearing dark glasses indoors, in an unlit room..