USD/CAD was little changed on Monday after a brief wobble following stronger Canadian inflation data, trading around 1.4165 and holding near its highest level since April 2025. Statistics Canada reported May headline CPI at 3.2% year on year, up from 2.8% in April, with higher petrol prices driving the pickup. Core measures were steadier: the Bank of Canada’s core CPI rose to 2.2% from 2.1%, keeping the focus on underlying price trends rather than the headline jump.
Markets continued to frame the inflation mix as consistent with the BoC keeping rates on hold, while expectations in the US have tilted towards a possible Federal Reserve hike by year-end after last week’s policy meeting. The US Dollar remained supported as the Dollar Index (DXY) traded near 101, close to a 13-month high, even as risk tone improved on progress in US-Iran negotiations. Softer oil prices linked to that optimism also weighed on the commodity-sensitive Canadian dollar. Canada’s calendar is empty for the rest of the week, although BoC governor Tiff Macklem is due to speak on Tuesday, while US attention turns to the PCE Price Index.
Monetary Policy Divergence and Outlook
Given the clear divergence in monetary policy, we see a strong case for further USD/CAD upside. The Federal Reserve’s hawkish stance contrasts sharply with the Bank of Canada, which appears sidelined by stable core inflation. This policy gap is the primary driver for our strategy in the coming weeks.
The Canadian inflation numbers are misleading, and we should look past the hot headline print. Central banks typically focus on core inflation, which at 2.2% is very close to the BoC’s 2% target, giving them little reason to act. This reinforces the view that Canadian interest rates will remain stagnant for the foreseeable future.
On the other hand, the U.S. dollar continues to be supported by expectations of a Fed rate hike. Current market pricing, reflected in overnight index swaps, suggests a greater than 70% probability of a rate increase by the end of the year. The upcoming PCE Price Index report will be critical and could solidify these expectations if it also comes in hot.
Strategy and Key Market Risks
Adding to the pressure on the Canadian dollar is the decline in oil prices. Historically, USD/CAD has a strong inverse correlation with the price of WTI crude, often ranging between -0.6 and -0.8. As optimism around US-Iran negotiations weighs on oil, we expect this headwind for the loonie to persist.
We believe the most effective way to position for a continued move higher is through call options on USD/CAD. This allows us to capture potential upside while defining our maximum risk to the premium paid. Looking at historical precedent, a similar policy divergence between 2014 and 2016 pushed the pair from 1.10 to above 1.46, suggesting significant room to run.
We will be closely watching for any hawkish surprises from Governor Macklem tomorrow, although we view this as a low probability event. The key risk to our position is a much softer-than-expected US PCE reading later this week. A weak number could cause markets to reassess the Fed’s path and trigger a pullback in the pair.
