The Canadian dollar is at risk of dropping below 70 cents U.S. because the greenback is surging due to expectations that the United States Federal Reserve will hike rates instead of cutting them. The loonie on Friday fell to 70.56 cents U.S. in mid-morning trading, well off its year-to-date high of 74.1 cents U.S. in late January, and now sits at its lowest point in about a year.
Brutal Selloff for the Loonie
Shaun Osborne, Bank of Nova Scotia's chief currency strategist, described the Canadian dollar selloff this week as "particularly brutal," noting a 1.2 percent gain for the greenback, the "sharpest" since the loonie slumped badly in the spring. In the short term, he said the U.S. dollar rally could push the Canadian dollar as low as 68.9 cents U.S.
"The U.S. dollar is strengthening into the end of the second quarter and its gains are being driven by fundamentals as markets have moved to re-price a considerable amount of Fed tightening in the aftermath of the June Federal Open Market Committee meeting," Osborne explained.
Fed Rate Hike Expectations
The U.S. dollar index, which measures the greenback against a basket of other major currencies including the Canadian dollar, rose 1.3 percent from Wednesday to Friday on expectations that the Fed will hike interest rates from their current level of 3.5 percent to 3.75 percent sooner than had been expected. Prior to the Fed meeting on Wednesday, markets were fully pricing in a rate hike no sooner than March 2027. However, markets are now betting on a rate hike of 25 basis points as soon as the Oct. 28 Fed meeting, with an 88 percent chance of a hike coming in September.
Widening Interest Rate Differential
All that has spelled bad news for the Canadian dollar as the interest rate differential between the loonie and the greenback appears set to widen. The Bank of Canada on June 10 held interest rates at their current level of 2.25 percent for the fifth straight time, and most economists expect policymakers to continue holding rates for the remainder of the year. As a result, the higher rates on offer in the U.S. are more attractive to investors, pulling them away from the loonie. The U.S. dollar has also benefited from its haven status.
"The Canadian dollar has suffered through the latter half of the second quarter, weakening to fresh 2026 lows on the back of a material widening in U.S.-Canada yield spreads," Osborne said. "The Bank of Canada's cautious hawkishness has offered a minor headwind, especially when contrasted with the material shift in the Fed's outlook."
Other Factors Weighing on the Loonie
But interest rates are not all that is hitting the loonie, according to Sarah Ying, head of currency strategy at CIBC Capital Markets fixed income, commodity and currency unit. In a note on June 19, she said current risks favor the U.S. dollar, adding further pressure on the Canadian currency. The combination of a stronger greenback, widening yield spreads, and risk aversion has created a challenging environment for the loonie, with potential for further declines in the coming weeks.
