USD/CAD Pair Driven by Widening Rate Gap and Trade Tensions

The USD/CAD pair continues to trade below the 1.4000 psychological mark and near its August 7 low, despite gains for the second straight week.

This bearish trend is largely due to the widening US-Canada rate gap, which has resulted in a tailwind for the USD/CAD pair.

The Canadian Dollar (CAD) has been underperforming against its American counterpart since the Bank of Canada maintained its key policy interest rate at 2.25% earlier this month, while the US Federal Reserve raised its benchmark rate by 25 basis points to a range of 3.75-4.00% on Wednesday.

Scotiabank strategists note that the renewed widening in US-Canada rate differentials is weighing heavily on the Loonie, with the 'Fed/BoC policy rate differential back to 175bps, where it spent much of last year', adding that their fair value model indicates an equilibrium exchange rate of 1.3894, indicating a degree of USD overvaluation in current spot rates.