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USD/CAD expected to weakned into year end

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UBS analysts highlighted the possibility of the Bank of Canada (BoC) implementing a rate cut before the U.S. Federal Reserve, amid economic slowdown concerns.

The Canadian dollar (CAD) is expected to face only modest inflationary pressures from a weaker currency as a result. UBS predicts the first BoC rate cut could occur in the summer, likely by July, which may provide short-term support for the CAD.

The Canadian economy, closely tied to the United States, is experiencing a divergence as manufacturing sectors weaken globally, leading to reduced cross-border economic effects.

Canada’s limited fiscal support and consumers’ vulnerability to high interest rates have contributed to a sharper economic downturn compared to its U.S. counterpart. This sets the stage for a BoC rate cut, potentially preceding the Fed’s policy easing.

UBS suggests that while the CAD could see some benefit from a BoC decision to maintain rates in the next week’s policy meeting, the impact of U.S. factors on the foreign exchange rates will likely limit the BoC’s influence.

The firm anticipates that later in the year, as the USD weakens and the Fed eases policies, the CAD will be positioned to gain, supported by a shift in relative rate outlook and improved risk sentiment.

In terms of investment, UBS notes that while a BoC hold could initially favor the CAD, the subsequent rate differentials might be negative.

However, once broader USD weakness emerges, the CAD is expected to benefit. The resistance level for the USD/CAD pair remains at 1.3850, with support seen at 1.34 and 1.32. UBS favors call-selling strategies with strikes around the resistance level.

The analysis also outlines risk factors that could lead to a rally in the USD/CAD pair, including a hard landing in the U.S., Canada, or globally, a significant drop in energy prices, or a more pronounced easing cycle by the BoC.

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