UBS analysts highlighted the possibility of the Bank of Canada (BoC) implementing an interest rate cut ahead of the US Federal Reserve, amid fears of an economic slowdown.
The Canadian dollar (CAD) is expected to face modest inflationary pressures as a result. UBS expects the Bank of Canada to make its first rate cut in the summer, likely by July, which could provide short-term support for the Canadian dollar.
The Canadian economy, closely linked to the United States, is diverging as manufacturing sectors weaken globally, leading to reduced cross-border economic impacts.
Canada's limited fiscal support and consumers' exposure to high interest rates have contributed to a sharper economic contraction than its American counterpart. This paves the way for a rate cut from the Bank of Canada, which could precede the Fed's policy easing.
UBS notes that while the Canadian dollar may see some benefits from the Bank of Canada's decision to hold interest rates at next week's policy meeting, the impact of US factors on foreign exchange rates will likely limit the Bank of Canada's influence.
The firm expects that later in the year, as the US dollar weakens and the Fed eases its policies, the Canadian dollar will be positioned to rise, supported by a shift in relative price expectations and improved risk sentiment.
In terms of investing, UBS notes that while the Bank of Canada contract could initially favor the Canadian dollar, subsequent spreads could be negative.
However, once broader US dollar weakness emerges, the Canadian dollar is expected to benefit. The resistance level for this pair remains at 1.3850, with support at 1.34 and 1.32. UBS prefers call selling strategies with strikes around the resistance level.
The analysis also identifies risk factors that could send the USD/CAD pair higher, including a sharp decline in the US, Canada or globally, a significant decline in energy prices, or a more pronounced easing cycle by the Bank of Canada.
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