Of rates & the dollar

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   By Guest Blogger Ryan Lewenza

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The Bank of Canada (BoC) recently paused their interest rate cuts after seven consecutive cuts. Central banks have a difficult road ahead as they must deal with opposing forces from Trump’s tariffs – potentially lower economic growth and higher inflation (i.e., stagflation). The question many are asking is, will the BoC continue to lower interest rates or are we near the end of this easing cycle?

Let’s start with a quick look back at Canadian interest rates. The BoC started hiking rates in early 2022 as inflation started to rise, where they hiked rates from the low of 0.25% to a peak of 5% in the summer of 2023. Then, as inflation started to subside, the BoC started to cut rates last summer, with rates declining from 5% to the current 2.75%. With Canadian interest rates being cut effectively in half, clearly, we’re getting closer to the bottom in interest rates.

We think there’s still one to two more interest rates cuts coming this year, so we’re getting closer to the end but, we’re not there yet. Why do we think this?

First, our economy is struggling and could weaken further in part due to the tariffs. Last month our economy shed 32,000 jobs with our unemployment rate rising to 6.7%, which is near its highest level since 2021. The BoC highlighted this slowdown in our economy in their Monetary Policy Report (MRP).

This gets me to the second point, which is the negative impact of the tariffs. In the MPR they noted that tariffs impact our economy in two ways – first directly through the uncertain trade policies and secondly how this trade uncertainty then weighs on consumers, the labour market and business spending.

In the report they provided two scenarios on the tariffs. Scenario 1 assumes the tariffs are negotiated away, where economic activity slows but then picks up later this year. Scenario 2 assumes a protracted tariff war, which results in a significant global and Canadian recession. You can see how critical these tariffs are to the outlook and how binary the outcome is.

Third, inflation has slowed in Canada and is currently around the BoC’s 2% target, so this gives them some flexibility to cut rates further.

Finally, the bond markets are pricing in another cut or two. Interest rate futures put a cut at the June meeting at 50% and 100% by the July meeting. By the end of the year the market is pricing in a 70% chance of two cuts, which would take the overnight rate down to 2.25%.

So, given all this, we see high odds of one and potentially two more cuts by the BoC this year.

Outlook for Canadian overnight rate

Source: Bloomberg, Turner Investments

The implications of this are that we could see Canadian bonds rise from here (bond prices move inversely with interest rates). This could be good for Canadian dividend stocks, which often get a boost from lower interest rates, and could help the beleaguered Canadian housing market. Plus, we could see a further rebound in the Canadian dollar. Why?

Canadian dollar is off its lows

Source: Stockcharts.com, Turner Investments

To the surprise of many (not us!), the Canadian dollar has experienced a notable turnaround, rallying from the lows of 68 cents earlier in the year to around 72 cents currently. Many were calling for the Canadian dollar to continue to drop, with some even calling for our dollar to hit 50 cents versus the US dollar.

We took the other side of the debate and in a blog late last year predicted this turnaround. From the blog, “Sure, our dollar could drop a bit further in the short-term, but I think these dire calls for it to fall into the 50s is overblown, and in fact, I see our dollar surprising people in 2025. Call me a contrarian, but I’m predicting our Canadian dollar to recover next year.”

A key reason for this contrarian view was that the current divergence between the Canadian and US economies (the US economy was doing much better than Canada prior to Trump’s tariff war), would ‘mean revert’, and that our economies and monetary policies would get back in gear or converge over time. This is now happening.

The US economy just contracted in Q1 with a -0.3% GDP decline, marking the first negative quarter of growth since 2022. Not a great start for Trump’s presidency. And this is expected to continue for the remainder of the year. Coming into this year economists were forecasting the US economy to grow 2-2.5% this year, and many economists are now forecasting modest growth for this year and potentially a recession.

As a result of this slower economic growth, expectations for US rate cuts have been rising. The bond market is now pricing in 3-4 rate cuts this year from the Federal Reserve. This partly explains why we’ve seen the US dollar decline in recent months. Below is a chart of the US Dollar Index, which measures the US dollar versus a basket of foreign currencies. It’s down 10% since its peak earlier this year.

Add in the fact that foreign investors are starting to question ‘US exceptionalism’ and are moving money from the US and into other foreign markets. All of this has led to a steep decline in the US dollar and a rise in our Loonie.

All told, we see another interest rate cut or two from the BoC and see our Canadian dollar potentially rising from here as investors realize the US may encounter some difficulties as a result of Trump’s silly trade war.

US dollar index is under pressure

Source: Bloomberg, Turner Investments

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Investment Advisor, Private Client Group, of Raymond James Ltd.

Source: https://www.greaterfool.ca/2025/05/03/of-rates-the-dollar/