The Canadian Dollar's Ascent: Navigating Macroeconomic Divergence and Central Bank Policy in 2025

The U.S. dollar’s dominance in global markets has long been underpinned by its role as a reserve currency and the Federal Reserve’s policy credibility. However, 2025 is shaping up to be a pivotal year for the Canadian dollar (CAD), as macroeconomic divergence and divergent central bank strategies create a compelling case for CAD appreciation against the U.S. dollar (USD). Rosenberg Research argues that the CAD is on a trajectory toward parity (CAD/USD = 1.00) by 2025, driven by structural advantages in Canada’s economy and the U.S.’s growing fiscal and inflationary challenges [2]. This analysis explores the forces behind this shift and offers strategic insights for investors navigating the USD/CAD landscape.

Macroeconomic Divergence: Canada’s Structural Strength vs. U.S. Vulnerabilities

Canada’s economy is benefiting from a commodities supercycle, with energy and metals exports surging due to global demand for clean energy transition materials and geopolitical shifts in trade flows [2]. Oil prices, a critical determinant of Canada’s trade balance, have remained resilient, bolstering the CAD’s value. Meanwhile, the U.S. faces a conundrum: inflation remains stubbornly above the Fed’s 2% target, with core PCE inflation hitting 2.9% in July 2025 [1]. Deloitte forecasts that the Fed will cut rates by 50 basis points in Q4 2025, but these cuts will likely be reactive rather than proactive, reflecting policy uncertainty and the risk of a hard landing [3].

In contrast, the Bank of Canada has maintained a cautious stance, keeping its benchmark rate at 2.75% in July 2025, with inflation projected to stabilize near 2% in the medium term [1]. This divergence in monetary policy—higher rates in Canada versus anticipated easing in the U.S.—creates a tailwind for CAD strength. Historically, CAD has outperformed USD when the Bank of Canada’s rates exceed those of the Fed by more than 100 basis points, a scenario now increasingly likely [2].

Inflationary Pressures and Policy Pathways

Canada’s July 2025 inflation rate of 1.7% reflects a cooling in energy prices, driven by the removal of carbon levies and reduced geopolitical tensions [1]. While core inflation remains elevated (3.0% year-over-year for shelter costs), the Bank of Canada’s credibility in managing inflation expectations has mitigated long-term risks [5]. Conversely, U.S. inflation, at 2.7% headline and 3.1% core CPI, is trending upward, with tariffs on Chinese and Mexican goods exacerbating price pressures [1]. The Fed’s projected rate cuts, while intended to stimulate growth, risk further eroding USD value against a CAD supported by higher real rates and commodity-driven demand.

Strategic Positioning for Investors

The USD/CAD pair has traded between 1.36 and 1.38 in Q3 2025, with analysts forecasting a move toward 1.35 by year-end [3]. This trend reflects CAD’s resilience amid U.S. policy uncertainty, including erratic tariff policies and concerns about fiscal sustainability. For investors, this presents an opportunity to overweight CAD in portfolios, particularly through currency forwards or ETFs tied to Canadian equities and commodities. However, risks persist: a resurgence of U.S. tariffs or a collapse in oil prices could reverse CAD’s gains [3].

Rosenberg Research emphasizes that CAD’s undervaluation relative to fundamentals—such as its trade surplus and higher real interest rates—makes it an attractive long-term bet [2]. Investors should also monitor the Bank of Canada’s response to potential inflationary shocks, as a delay in rate cuts could further widen the policy gap with the Fed.

Conclusion

The Canadian dollar’s ascent is not a fleeting trend but a reflection of deeper structural forces: a commodities-driven economy, disciplined monetary policy, and a U.S. dollar weakened by fiscal imbalances and inflationary pressures. While the path to CAD/USD parity is not without risks, the macroeconomic and policy divergence between the two nations provides a robust foundation for CAD strength. Investors who position themselves accordingly may find USD/CAD to be a compelling trade in the second half of 2025.

Source:
[1] Monetary Policy Report—July 2025,
https://www.bankofcanada.ca/publications/mpr/mpr-2025-07-30/
[2] The Canadian Dollar's Rise: Navigating the Road to Parity,
https://www.ainvest.com/news/canadian-dollar-rise-navigating-road-parity-2025-2505/
[3] United States Economic Forecast Q2 2025,
https://www.deloitte.com/us/en/insights/topics/economy/us-economic-forecast/united-states-outlook-analysis.html
[4] USD/CAD, EUR/CAD & GBP/CAD – Bank FX Outlook,
https://www.mtfxgroup.com/fx-forecast/