Canadian Dollar and Commodity-Linked FX Strategy in a Deteriorating Trade Outlook

The Canadian dollar (CAD) and commodity-linked assets are navigating a treacherous crossroads in 2025, shaped by a perfect storm of geopolitical tensions, oil price volatility, and cautious monetary policy. As the U.S.-Canada trade war escalates and global energy markets reel from oversupply, investors must dissect the interplay of these forces to position portfolios for resilience—or capitalize on dislocation.

Geopolitical Tensions: A New Era of Trade Uncertainty

The U.S. imposition of 35% tariffs on Canadian steel, aluminum, and automotive exports has rewritten the rules of North American trade. These punitive measures, justified under the guise of “national security,” have triggered a 12.5% year-over-year decline in Canadian exports to the U.S. in June 2025. The ripple effects are profound: Canadian automakers are scaling back production, while energy firms like Suncor Energy are rerouting crude shipments to Southeast Asia.

The CAD's response has been paradoxical. Despite the trade war's drag on exports, the Canadian dollar has appreciated against the U.S. dollar in 2025, averaging 71.49 U.S. cents in April—a 2.7% gain from January. This resilience stems from the U.S. dollar's broader weakness, driven by erratic Trump-era trade policies and investor flight from U.S. assets. However, the loonie's strength masks underlying fragility. A breakdown in U.S.-Canada trade relations or a sharp escalation in tariffs could trigger a rapid reversal, as seen in the 3.4% monthly drop in metal exports in June.

Oil Price Volatility: A Double-Edged Sword for Commodity-Linked Assets

The energy sector, a cornerstone of Canada's economy, is under siege. WTI crude prices have plummeted over 20% since early 2025, hitting $55/bbl—the lowest in four years. OPEC+'s aggressive output hikes and U.S.-China trade tensions have exacerbated oversupply, while Canadian benchmark prices (WCS) have mirrored this decline. Yet, the oil sands sector has shown surprising resilience. S&P Global Commodity Insights forecasts record production of 3.5 million barrels per day in 2025, driven by low breakeven costs (averaging $27/bbl) and efficiency gains.

For investors, this duality presents a dilemma. While falling oil prices weigh on short-term revenues, the sector's structural advantages—low costs and operational flexibility—suggest long-term stability. However, bottlenecks in pipeline infrastructure could reemerge in 2026, limiting export capacity and dampening returns for commodity-linked assets.

Monetary Policy: The Bank of Canada's Tightrope Walk

The Bank of Canada has maintained its overnight rate at 2.75% through July 2025, signaling a cautious approach amid conflicting signals. While the first quarter of 2025 saw GDP growth driven by a pull-forward of exports, the second quarter contracted by 1.5% as U.S. demand waned. The central bank is now balancing inflationary pressures from trade disruptions against the risk of a weaker economy.

This ambiguity has left the CAD in a holding pattern. Analysts project a range-bound trajectory for the loonie in the second half of 2025, with potential for a move to the mid-1.30s by year-end if the U.S. dollar remains weak. However, a sharp escalation in tariffs or aggressive rate cuts by the Bank of Canada could destabilize this outlook.

Strategic Implications for Investors

1. Hedge CAD Exposure with Diversification: Given the trade war's unpredictability, investors should hedge CAD risk by diversifying into EUR and JPY, as seen in corporate strategies. This mitigates cross-border trade volatility while capitalizing on the U.S. dollar's weakness.
2. Prioritize Commodity-Linked Assets with Low Breakeven Costs: Oil sands producers with breakeven costs below $30/bbl (e.g., Suncor Energy) are better positioned to withstand price declines. Focus on firms leveraging efficiency gains over capital-intensive projects.
3. Monitor Policy Shifts and Tariff Developments: The Bank of Canada's next move—whether a rate cut or tightening—will hinge on trade war outcomes and inflation trends. A two-rate-cut scenario by December 2025 could bolster the CAD, but a trade war escalation would override this.

Conclusion: Navigating the Crossroads

The Canadian dollar and commodity-linked assets are at a crossroads, where geopolitical tensions, oil price volatility, and monetary policy intersect. While the immediate outlook is fraught with uncertainty, structural advantages in the energy sector and the U.S. dollar's fragility offer long-term opportunities. Investors who adopt a balanced approach—hedging currency risks, favoring resilient commodities, and staying attuned to policy shifts—will be best positioned to weather the storm.