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Investing.com -- Bank of America (NYSE:BAC) strategist Howard Du has trimmed the near-term forecast for USD/CAD to 1.38, citing balanced market forces in play as Canada’s economy attempts to navigate slowing growth, diverging monetary policy, and shifting investor sentiment. In his mid-year update, Du underscored that the foreign exchange pair continues to face “two-sided near-term risks” as stronger-than-expected GDP figures and equity outperformance offset dovish signals from the Bank of Canada.
Markets have become increasingly bearish on Canada’s economic outlook, with consensus expecting Q2 GDP to contract 1% on a seasonally adjusted annualized basis. However, BofA projects a more moderate decline of just -0.2%, aligning with the BoC’s more constructive Scenario 1 outlook from its April Monetary Policy Report.
Canadian equities have also provided an unexpected tailwind for the loonie. Since early April, TSX returns have outpaced global peers outside of the U.S., a trend BofA expects to continue as domestic cyclical indicators improve.
Despite these supportive forces, Du sees rate divergence as a limiting factor for Canadian dollar strength. He anticipates the BoC will cut policy rates three times in 2025 once core inflation retreats and notes that the labor market remains under stress with no peak yet in unemployment.
In the longer term, Du maintains that USD/CAD will trend gradually lower, extending a target of 1.35 into 2027. “We do not see USD/CAD below 1.30 in our current forecast horizon; Fed-BoC rate divergence and equilibrium are the supports,” he wrote in the report.
At the 1.30 level, CAD would no longer be undervalued against its long-term equilibrium range, according to BofA’s valuation models. However, unless global capital flows drive a sustained de-dollarization regime, Du believes investors will be reluctant to unwind the USD’s premium from recent years.
USD dynamics are also shifting as foreign exchange markets become more tied to equities than interest rate spreads. Still, Du flagged that “rates market moving from the current one BoC cut pricing to three cuts should still exert some upward pressure for USD/CAD” even amid changing correlations.