With the U.S. Federal Reserve kicking off its latest rate-cutting cycle with an aggressive half-point cut, the ripple effects are likely to be felt across global markets. For the Canadian dollar, the impact could be substantial, as shifts in interest rates and economic sentiment may weigh heavily on the currency’s future performance.
Here’s why the Fed’s ‘outsized’ rate cut could sink the Canadian dollar:
- Interest Rate Cycle Timing: A large rate cut by the U.S. Federal Reserve makes U.S. assets less attractive due to lower returns. Initially, this could lead to increased demand for foreign assets, including Canadian ones. However, if the Fed signals it’s nearing the end of its rate-cutting cycle, while the Bank of Canada remains uncertain or slower to act, investors may return to U.S. assets for more stability. This could reduce demand for the Canadian dollar, causing it to lose value over time.
- Commodity Prices: Canada’s economy is heavily reliant on commodities like oil, which are priced in U.S. dollars. A weaker U.S. dollar can reduce global demand for these commodities, hurting Canada’s export revenues and placing downward pressure on the Canadian dollar.
- Market Sentiment: A significant U.S. rate cut may spark concerns about global economic stability. In uncertain times, investors tend to flock to safer assets. Even if the U.S. dollar weakens initially, the U.S. is still seen as a stable economy, causing investors to avoid riskier currencies like the Canadian dollar, which could lose value as part of this broader shift to safer investments.
- Economic Growth Concerns: If the Fed’s aggressive rate cuts are seen as a response to a slowing U.S. economy, investors might also worry about Canada’s economic outlook, given the close ties between the two economies. A slowing U.S. economy could drag Canada’s economy down with it, causing further depreciation of the Canadian dollar.
All in all, while the U.S. dollar might take a temporary hit, the Fed’s rate cuts could end up causing bigger problems for the Canadian dollar in the long run, making it harder for the CAD to hold its value.
The Canadian dollar is currently trading at 1.3564 CAD against the US Dollar.
