ING anticipates a continued depreciation of the Canadian dollar relative to its G10 counterparts. This projection is underpinned by the Bank of Canada's increasingly dovish stance and an escalating tariff-related risk premium. Despite the currency's current stability, ING suggests that market participants are underestimating the impact of ongoing trade disputes. While a short-term upward trend for USD/CAD towards 1.39 is expected, potential rate adjustments by the Federal Reserve are likely to cap these gains by the end of the year.
The Canadian dollar's performance is currently exhibiting a degree of resilience, leading some market observers to apply a '2025 playbook' model. This framework suggests that trade escalations are often followed by negotiations, which tend to temper initial foreign exchange market reactions. This perception has, until now, confined the Canadian dollar's underperformance against its G10 peers to approximately half a percentage point, excluding broader movements of the US dollar. Furthermore, hedging expenses have remained relatively subdued compared to the initial surge in trade tensions witnessed in December 2024. However, ING's analysis diverges from this complacent outlook. The bank points to a reassessment of the Bank of Canada's monetary policy, leaning towards a more dovish stance, and a mounting risk premium associated with tariffs. These factors, according to ING, are compelling reasons why the Canadian dollar should experience a more significant underperformance against currencies such as the Australian dollar and the Norwegian Krone. In the immediate future, the trajectory for USD/CAD indicates a continued ascent, potentially reaching levels between 1.3920 and 1.3950. Nevertheless, ING's overarching bearish view on the US dollar, predicated on anticipated rate reductions by the Federal Reserve before the year's end, is expected to temper these gains as the fourth quarter approaches.
ING strategists believe that market participants are not adequately factoring in the potential economic repercussions stemming from the trade disagreements with Canada. Consequently, they foresee the Canadian dollar continuing to lose ground against other major currencies within the G10 group. This outlook persists despite the relatively subdued market reaction observed following the breakdown of trade discussions on August 22. Subsequent to these talks, 50% tariffs were imposed by the United States on Canadian goods valued at approximately $20 billion, with additional 50% levies on Canadian automobiles, auto parts, and steel scheduled to commence on January 1, 2027. Canada has responded with reciprocal tariffs of its own, also totaling $20 billion, including 50% duties on steel and aluminum, which are set to come into effect on September 8.
The financial institution highlights that the USD/CAD exchange rate has only risen by about 1.0% since the trade talks collapsed. When the broader appreciation of the US dollar is excluded, the Canadian dollar's underperformance against comparable currencies has been a mere half a percentage point. This restrained reaction is attributed by the bank to markets still adhering to a '2025 playbook' regarding US protectionist measures, where initial escalations are widely expected to lead to eventual negotiations. Hedging costs for the Canadian dollar, as gauged by the premium of implied over realized volatility, remain significantly lower than during the initial flare-up of US-Canada trade tensions in December 2024. This further suggests that markets are not yet pricing in a prolonged deterioration of trade relations. ING identifies potential for the USD/CAD pair to advance towards the 1.3920-1.3950 range in the very near term, arguing that the pair is currently trading slightly below its short-term fair value, with no tariff risk premium factored in. However, in the longer term, ING projects that any significant upside will be curtailed by a broader weakening of the US dollar. The bank forecasts that the Federal Reserve will refrain from further rate hikes by year-end and will unwind an estimated 10 basis points of hawkish pricing around the September meeting, followed by 26 basis points by December. This leads ING to maintain its forecast for USD/CAD at 1.39 by the conclusion of the third quarter and 1.38 by the end of the fourth quarter.
Regarding interest rates, ING observes that economic headwinds and a lack of corporate pricing power, exacerbated by slack in the labor market, are prompting economists to adopt a more cautious stance on the Bank of Canada's tightening policies. Market expectations for cumulative rate hikes by April 2027 have decreased from 63 basis points at the beginning of the week to 44 basis points. The bank currently anticipates one rate increase in the second quarter of 2027 and another in the fourth quarter, noting that expert consensus is divided between one and two hikes for the year overall. ING also predicts that the Australian dollar and Norwegian Krone, bolstered by higher carry interest and stronger fundamental indicators, will significantly outperform the Canadian dollar as the trade standoff persists.
In conclusion, ING maintains a pessimistic outlook for the Canadian dollar's short-to-medium-term trajectory, primarily due to the ongoing trade disputes with the United States and the Bank of Canada's increasingly dovish stance. Despite the currency's unexpected resilience so far, the firm believes that market valuations have yet to fully incorporate the severity of the tariff-related risks. While some near-term upward movement for USD/CAD is anticipated, the overarching expectation of Federal Reserve rate cuts is projected to limit these gains by the end of the year, solidifying ING's forecast for a weaker Canadian dollar against key G10 currencies.