**Canadian Dollar Drops to Seven-Month Low Following U.S. Federal Reserve Guidance**
*By Fergal Smith | The Globe and Mail | With Additional Commentary and Reporting*
The Canadian dollar recently hit its lowest level since mid-March, as it continued a downward trajectory driven by a combination of hawkish signals from the U.S. Federal Reserve and a stagnating domestic economy. Analysts point to widening interest rate differentials, softening commodity prices, and slowing growth metrics as key pressures on the loonie.
On Thursday, the currency dropped as low as 1.3789 against the U.S. dollar, translating to approximately 72.49 cents U.S. This marks the weakest closing price for the Canadian dollar in nearly seven months. Overall, the loonie experienced a 0.3 percent depreciation on the day.
### Key Drivers Behind the Canadian Dollar’s Decline
Several interrelated factors have contributed to the Canadian dollar’s latest slump, including monetary policy divergence, economic stagnation in Canada, falling oil prices, and broader shifts in global risk sentiment.
#### 1. U.S. Federal Reserve Outlook Tugs the Loonie Lower
The single most influential immediate factor affecting the Canadian dollar in recent weeks has been the market’s reaction to renewed hawkishness from the U.S. Federal Reserve.
– The Fed held interest rates steady at its latest policy meeting, but signaled that borrowing costs are likely to remain elevated into 2024.
– Crucially, the Fed’s “dot plot” projections now forecast only two rate cuts next year, down from four previously anticipated.
– U.S. Treasury yields surged on the back of this outlook, especially the 10-year yields, which touched a 16-year high of 4.49 percent, increasing the attractiveness of U.S. financial assets.
The combination of higher U.S. yields and a strong U.S. dollar continues to place downward pressure on the Canadian dollar. Investors favor the greenback in this environment of “higher for longer” interest rates.
#### 2. Bank of Canada Faces a Dimming Economic Outlook
While the Fed remains focused on curbing inflation, the Bank of Canada (BoC) is navigating a different landscape. The Canadian economy has shown signs of stagnation, leading traders to anticipate that the BoC may have already reached the end of its tightening cycle.
Key economic indicators in Canada include:
– Real GDP growth in the second quarter was flat (0 percent annualized), missing expectations and raising concerns about a potential economic contraction in the second half of 2023.
– The unemployment rate ticked higher in recent months, and job growth has moderated.
– Inflation, while still above the BoC’s two percent target, rose to four percent in August, but much of the increase was driven by volatile items such as gasoline.
Economists say the BoC is in a far more difficult position than the Fed when it comes to delivering additional interest rate hikes. A softer economic backdrop makes the case for further policy tightening less compelling, even in the face of sticky inflation. As a result, rate differentials between Canada and the U.S. may increase further.
#### 3. Commodity Prices Fail to Support Canadian Dollar
Traditionally, the Canadian dollar benefits from strength in commodity markets, particularly crude oil, due to Canada’s status as a major energy exporter. However, recent price action in oil markets has failed to lift the loonie to the extent typically expected.
– West Texas Intermediate (WTI) crude prices have hovered near the psychologically important $90 per barrel level.
– Despite tight global supplies and Saudi-led OPEC+ production cuts, analysts are growing cautious about the sustainability of further gains, especially with concerns about global demand.
– The correlation between the loonie and oil appears to have weakened in recent weeks amid overriding focus on monetary policy divergence.
Given these dynamics, the loonie has not been able to capitalize on high crude oil prices — a development that normally serves as a tailwind
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