The Canadian Dollar has been steady versus the US Dollar, while other G10 peers have advanced. Scotiabank attributes the drag to Canada’s risk profile and a widening policy gap between the Bank of Canada and the Federal Reserve, which is feeding through to interest rate differentials as markets reprice a softer BoC path alongside a firmer Fed outlook.
On the technical side, the bank says USD/CAD has moved higher but is encountering resistance, with momentum fading around key moving averages. Scotiabank’s fundamental valuation framework also points to CAD undervaluation, putting its fair value estimate for USD/CAD at 1.3672, and it expects range-bound trading in the near term with scope for a CAD rebound if incoming Canadian data outperforms expectations.
Policy Divergence And Interest Rate Differentials
We see the widening gap between the Bank of Canada and the Federal Reserve’s policies as the primary driver for the Canadian dollar. With overnight index swaps now pricing in an 85% chance of a rate cut by the Bank of Canada at its June 5th meeting, the divergence is becoming more pronounced. This contrasts sharply with the U.S., where recent Personal Consumption Expenditures (PCE) data at 2.8% supports the Fed maintaining a restrictive stance.
This policy difference has pushed the spread between Canadian and US 2-year government bond yields to -70 basis points, a level not seen since late 2005. This growing interest rate differential creates a significant headwind, making it less attractive to hold Canadian dollars. For now, this dynamic will likely keep the USD/CAD pair elevated.
Technical Resistance And Trading Strategies
However, the upward momentum in USD/CAD is clearly facing friction, repeatedly failing to sustain gains above the 1.3850 resistance level. This technical stalling suggests the market is hesitant to push the pair higher, despite the supportive interest rate environment. Our models also point to a fundamental fair value for the pair closer to 1.3672, indicating the Canadian dollar is currently undervalued.
Given this stalled momentum, we believe selling out-of-the-money call options on USD/CAD with strike prices above 1.3900 is a prudent strategy for the coming weeks. This allows traders to collect premium while the pair likely remains in a range, capped by strong technical resistance. The position profits from time decay as long as the upward rally remains contained.
As a hedge against a surprise rebound in the Canadian dollar, we also see an opportunity in buying longer-dated, inexpensive put options on USD/CAD. If upcoming Canadian economic data, such as employment or inflation figures, exceeds expectations, the currency could quickly strengthen towards its fundamental value. This provides a low-cost way to position for a potential CAD recovery.
