The Canadian dollar (CAD or loonie) was the worst-performing G10 currency in May, reflecting the crude oil price move and the unfavorable move in relative rates, said MUFG.
Brent crude oil fell 19.3% in May, with optimism maintained that a peace deal will be agreed between the United States and Iran, noted the bank.
The two-year U.S.-Canada spread surged by 32bps in May, which points to upside risks for USD/CAD if the current level of spread is maintained, stated MUFG. The last time the spread was consistently at these levels (110bps to 120bps) was late 2024, early 2025, when USD/CAD was trading in a range between 1.42 and 1.44.
The spread widening is related more to U.S. yields moving higher, although Canada front-end yields have also declined, reflecting an easing of Bank of Canada rate hike expectations, it pointed out. The OIS market now prices 25bps by December 2026, down from 52bps at the end of April.
The April jobs report was a key catalyst for this reappraisal of action from the BoC, with an 18,000 drop in employment lifting the unemployment rate to 6.9%. The inflation data added to the shift in expectations, with the core CPI year-over-year rate falling from 1.9% to 1.5% and the median and trimmed rates were weaker than expected as well.
If a peace deal emerges and the price of crude oil declines further, the need for BoC rate hike action may disappear completely, added the bank. However, US yields will also decline, and broader risk will be underpinned, and in those circumstances, MUFG expects USD/CAD to drift lower again in line with the bank's broader view of renewed US dollar (USD) depreciation.
CAD gains would likely prove more modest than for other non-dollar G10 currencies, according to the bank.