The outlook for the Canadian dollar will depend heavily on whether US-Canada rate differentials begin to narrow, according to TD Economics.
TD's base case is that moderating U.S. inflation and slower growth will allow the Federal Reserve to gradually cut rates toward 3.25% in 2027, reducing the appeal of US dollar assets and providing support for the Canadian dollar, the bank wrote in a Thursday note.
"The main risk is that the U.S. economy proves strong enough to keep those rate differentials wider for longer," wrote Andrew Hencic, director and senior economist at TD, in the note.
A resilient U.S. economy could limit Fed easing, while stronger American productivity growth may keep the neutral rate higher than in Canada. A higher US neutral rate would help keep the yield advantage supporting the greenback.
TD added that its baseline remains for a gradual loonie recovery as US policy eases, but a persistent US productivity advantage could delay the adjustment. In this scenario, the Canadian dollar could remain rangebound around 71 to 72 cents through mid-2027 as rate and growth differentials continue to favor US assets.