The USD/CAD pair has declined due to general weakness in the US dollar. The Bank of Canada’s (BOC) business outlook survey worsened in the first quarter, with the Business Outlook Survey (BOS) indicator falling below average.
One-year inflation expectations rose to 3.61% in March, the highest level since October 2023. However, longer-term inflation expectations remain stable around 2%, suggesting potential for the BOC to reduce rates.
Market Estimates For Rate Changes
Market estimates suggest a 70% possibility of a 25 basis points cut to the BOC policy rate, bringing it to 2.50% during the April 16 meeting, with nearly 75 basis points of easing anticipated over the next year.
We’ve seen a reactive move in the USD/CAD pair, largely brought on by the weaker tone taken by the US dollar. This has pushed the loonie into firmer territory, despite domestic pressures in Canada hinting at a slower economic pace. Traders understood this as the US dollar giving up some of its recent strength rather than strong demand for the Canadian dollar itself.
In the latest Bank of Canada Business Outlook Survey, there’s been a visible downturn in corporate sentiment. The BOS indicator slipped below its long-term average, a rare occurrence and one that signals weaker expectations from firms going forward. When businesses offer cautious guidance on hiring and investment, the central bank typically takes notice.
We also can’t overlook what’s unfolding on the inflation front. Short-term price pressures are building again. The one-year inflation outlook climbed to 3.61% in March — the highest since October last year. That’s not an ideal reading. But before jumping to conclusions, keep in mind that long-term expectations have steadied near the Bank of Canada’s comfort zone at 2%. That steadiness effectively gives the central bank some breathing space.
Derivatives And Market Implications
Taking all of this into account, market pricing now reflects a strong chance — about 70% — that the Bank of Canada might lower its policy rate by 25 basis points at the upcoming April meeting. There’s even a mild expectation that cuts totalling 75 basis points are likely over the next 12 months.
As for those of us eyeing derivatives, we’d do well to digest the alignment between inflation expectations and the policy path. Short-dated options may already price in this expected easing, suggesting that premiums are reflecting lower rate volatility ahead. However, if inflation persists in the near term while businesses pull back, additional two-way volatility could emerge across rate and currency products.
Holders of CAD interest rate futures and swaptions may want to model slightly asymmetric rate cut probabilities — more weight towards two, fewer towards four cuts — rather than banking on a uniform glide path. An early move in April might front-load some of the risk premium, so flattener trades could see renewed appetite.
In currency markets, implied vols around the CAD crosses remain relatively muted, despite the shift in fundamentals. That won’t last if forward guidance from the Bank underscores slower growth with uneven inflation pressures. We ought to watch for repricing in skews if this narrative strengthens.
For now, contracts tied to the April and June meetings bear the most attention — that’s where policy risk is densest. Traders might hedge accordingly, especially around the BOS publication dates or any data releases on wages and job persistence. These remain the BOC’s focus, and we should let that guide our positioning more than any single inflation print.
