The USD/CAD currency pair is trading at pandemic-era highs as Canada’s loonie grapples with a loss of its safer commodity currency status. Donald Trump’s threat of imposing 25% tariffs on Canadian goods has added a layer of volatility, threatening a full-scale North American trade war that could push USD/CAD to the 1.50 mark. Meanwhile, the Bank of Canada’s dovish stance and political uncertainties in Canada are compounding the loonie’s woes.
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2% Risk Premium Priced Into CAD
Since the start of 2024, USD/CAD has appreciated 7.5%, driven by the growing divergence in monetary policy between the Federal Reserve and the Bank of Canada (BoC). The Fed’s hawkish stance contrasts sharply with the BoC’s aggressive rate cuts, which were initially justified by Canada’s lower inflation and softer growth.
However, Trump’s tariff threats have introduced a 2% risk premium into the currency pair, indicating bearish pressures on the loonie unrelated to traditional market factors like interest rates or commodity prices. Historically, such premiums peaked at 2.5% during the 2018 USMCA negotiations, which had far less severe economic implications than the current tariff threat.
BoC Cuts Leave CAD in a Vulnerable Position
The Bank of Canada has undertaken substantial rate cuts—175 basis points so far this year—to support Canada’s rate-sensitive economy. Yet, this policy has left CAD increasingly vulnerable. Markets are pricing in another two rate cuts in 2025, potentially pushing the BoC’s policy rate to 2.75%.
If a full-fledged trade war with the U.S. materializes, the BoC may face pressure to cut rates even further, exacerbating the loonie’s depreciation. With every 25-basis-point widening in the USD/CAD swap rate differential, USD/CAD could climb by three big figures, potentially pushing the pair past 1.45 and toward 1.50 in a worst-case scenario.
Canadian Politics: A Wild Card
Political developments in Canada add another layer of uncertainty for the loonie. Finance Minister Chrystia Freeland’s unexpected resignation has heightened speculation of a snap election before October 2025. Trade relations with the U.S. are expected to be a central issue in the campaign.
Polls suggest a Conservative majority led by Pierre Poilievre is likely, which could bring a shift in fiscal and trade policies. Poilievre has criticized Trump’s tariff threats but may leverage his closer political alignment with the former U.S. president to ease tensions. His focus on expanding energy production and looser fiscal policies could be medium-term positives for CAD, but much depends on his ability to renegotiate trade agreements and de-escalate tariff disputes.
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Watch the Snowball Effect
The Canadian dollar faces risks from multiple fronts:
- Trade Tensions: The possibility of a 25% tariff on Canadian exports threatens economic stability.
- BoC’s Dovish Stance: Further rate cuts may accelerate CAD’s depreciation.
- Political Uncertainty: A snap election could delay or complicate efforts to address trade issues.
If these risks converge, USD/CAD could surpass 1.50, a level unseen since the early 2000s. However, such a rapid rise could also trigger a sharp correction, particularly if market fundamentals fail to support extended loonie weakness.
The loonie’s status as a safer, low-volatility commodity currency is under siege as USD/CAD trades near pandemic highs. Between trade tensions, aggressive BoC rate cuts, and a volatile political landscape, the outlook for CAD remains fraught with uncertainty. Investors should closely monitor developments in U.S.-Canada trade relations, central bank policies, and the evolving political landscape in Canada as these factors will shape the loonie’s trajectory in the months to come.
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