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Rate Differentials, Trade Deal Renegotiations Are Weighing on Canadian Dollar, Says ING

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Canada releases Q1 gross domestic product data on Friday at 8:30 a.m. ET, said ING.

Expectations are for "tepid" 1.5% quarter-over-quarter annualized growth after Q4's grim 0.6% contraction, writes the bank in a note. But such an outdated piece of information will only matter for the Bank of Canada if it "very meaningfully" deviates from consensus.

The Canadian dollar (CAD or loonie) took a breather on Friday, but remains a key laggard in the G10 in May, stated ING. In the bank's short-term fair value model, global equities and short-term rate differentials are doing the heavy lifting in driving the pair.

Further de-escalation and improved risk sentiment would likely push USD/CAD lower, but relative rates continue to provide an important offset, pointed out ING. Canadian inflation and labor market dynamics argue against any near-term hawkish shift from the BoC, and markets remain more comfortable pricing out Canadian central bank tightening than Federal Reserve tightening.

USMCA trade deal renegotiations also remain a key risk for CAD, added the bank. United States Trade Representative Jamieson Greer said this week that issues with Canada are "significant." As in 2020, President Donald Trump may escalate tariff threats ahead of any eventual deal.

Even if a new USMCA agreement is ultimately reached, prolonged negotiation uncertainty could weigh on Canadian business sentiment and the labor market, further reducing the likelihood of a BoC hawkish response, according to ING.

In the bank's baseline scenario -- which is rather optimistic on Middle East developments -- ING has USD/CAD trading back to 1.37 by the end of June and 1.36 by the end of Q3. That embeds some risk premium on CAD related to USMCA renegotiations, keeping the loonie a laggard relative to other G10 commodity currencies.

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