USDCADBank of Canada (BoC) June 2025 Interest Rate Decision
The BoC held its key interest rate steady at 2.75% on June 4, 2025, marking the second consecutive hold after a series of cuts totaling 225 basis points since mid-2024.
The Bank Rate remains at 3.00%, and the deposit rate at 2.70%.
The decision reflects ongoing uncertainty from U.S. trade policies and tariffs, which continue to pose risks to Canada’s economic growth and inflation outlook.
The BoC emphasized the need to monitor the effects of trade tensions and inflation pressures before making further moves.
The next BoC rate announcement is scheduled for July 30, 2025.
Federal Reserve (Fed) June 2025 Interest Rate Decision
The Fed held its target federal funds rate at 4.25–4.50% in its June 2025 meeting, maintaining a cautious, data-dependent stance amid mixed inflation and labor market signals.
Recent data showed inflation moderating but still above target, and the labor market softening but resilient, leading the Fed to pause rate changes while assessing incoming economic information.
Market pricing indicates a growing probability of a rate cut later in 2025, possibly starting in September, contingent on sustained disinflation and labor market trends.
The Fed continues to monitor risks from tariffs and global economic uncertainties.
JUNE 18th economic data will be watched by BOC Gov Macklem Speaks and BOC Summary of Deliberations
Federal Reserve will update Federal Funds Rate 4.50% 4.50%,FOMC Economic Projections,FOMC Statement and FOMC Press Conference
In summary: Both the BoC and Fed paused rate changes in June 2025, reflecting a cautious approach amid economic uncertainties—trade tensions for Canada and inflation/labor market data for the US. Markets expect potential easing later in the year if conditions deteriorate
1. USD/CAD and Oil Price Correlation
Strong Negative Correlation:
USD/CAD and oil prices exhibit a strong inverse correlation. When oil prices rise, the Canadian dollar (CAD) tends to appreciate against the US dollar (USD), causing USD/CAD to fall, and vice versa.
Reason: Canada is a major oil exporter (over 3 million barrels/day), so oil revenues significantly impact Canada’s trade balance and economic health. Higher oil prices improve Canada’s terms of trade and strengthen CAD.
Recent Trends:
Although this correlation remains strong, its intensity has somewhat weakened recently due to other factors like global risk sentiment and trade dynamics. Still, oil remains a key driver of CAD strength.
2. USD/CAD and 10-Year Bond Yields
Interest Rate Differentials Influence:
The difference between US and Canadian 10-year government bond yields affects USD/CAD. A higher US yield relative to Canada tends to strengthen USD versus CAD, pushing USD/CAD higher. Conversely, if Canadian yields rise relative to US yields, CAD strengthens, lowering USD/CAD.
Risk Sentiment and Yield Movements:
Bond yields reflect economic growth expectations and monetary policy outlooks. Diverging economic conditions or central bank actions between the US and Canada influence these yields and thus USD/CAD.
Example: If US yields rise due to Fed tightening while Canadian yields stay stable, USD/CAD may rise.
3. Central Bank Interest Rate Decisions
Monetary Policy Impact:
The Federal Reserve (Fed) and Bank of Canada (BoC) interest rate decisions are crucial drivers of USD/CAD.
Rate Hikes: If the Fed raises rates or signals hawkishness while BoC holds or cuts, USD tends to strengthen against CAD, pushing USD/CAD higher.
Rate Cuts: Conversely, if BoC hikes or signals hawkishness and Fed eases, CAD strengthens, lowering USD/CAD.
Policy Divergence: Market expectations around these decisions create volatility in USD/CAD.
4. Carry Trade Advantage
Carry Trade Basics:
Carry trade involves borrowing in a currency with low interest rates and investing in a currency with higher rates to earn the interest differential.
USD/CAD Context:
If Canadian interest rates are higher than US rates, investors may borrow USD to invest in CAD assets, supporting CAD and lowering USD/CAD.
Interest Rate Differentials: The attractiveness of carry trades depends on the interest rate spread between the two countries and market risk appetite.
Risk Considerations: Carry trades can unwind quickly during market stress, causing sharp USD/CAD moves.
5. Uncovered Interest Rate Parity (UIP)
UIP Theory:
Uncovered Interest Rate Parity (UIP) is an economic and financial theory that explains the relationship between interest rates and exchange rates between two countries.
Key Points of UIP:
Definition: UIP states that the difference in nominal interest rates between two countries equals the expected change in exchange rates between their currencies over the same period. In other words, if one country has a higher interest rate, its currency is expected to depreciate relative to the currency of the country with the lower interest rate.
Implication: This means investors should expect no arbitrage opportunities from interest rate differentials alone because any potential gains from higher interest rates in one country will be offset by losses from currency depreciation.
Example:
Suppose the US has a 6% interest rate and India has a 14% interest rate. According to UIP, the Indian rupee is expected to depreciate against the US dollar by approximately 8% (the difference in interest rates) over the investment period. So, although an investor might earn higher interest in India, the currency depreciation offsets the gain.
Relation to Law of One Price: UIP is similar to the "Law of One Price," which states that identical goods or securities should have the same price globally when adjusted for exchange rates.
Difference from Covered Interest Rate Parity (CIP):
UIP does not involve hedging exchange rate risk with forward contracts; it uses expected future spot rates.
CIP involves using forward contracts to lock in exchange rates, eliminating currency risk.
Formula:
The expected change in exchange rate ≈ difference in interest rates between two countries.
USD/CAD Implication:
Traders watch interest rate differentials and expectations to forecast USD/CAD moves, but must consider that other factors (oil prices, risk sentiment) also influence the pair.
Summary Table
Factor Impact on USD/CAD Explanation
Oil Prices Higher oil → CAD strengthens → USD/CAD ↓ Canada’s oil exports support CAD
10-Year Bond Yield Differential Higher US yields → USD strengthens → USD/CAD ↑ Reflects monetary policy and growth outlooks
Central Bank Rate Decisions Fed hike > BoC hike → USD/CAD ↑ Interest rate differentials drive flows
Carry Trade Higher CAD rates → carry trade inflows → USD/CAD ↓ Investors seek higher yields in CAD
Uncovered Interest Rate Parity Interest rate gap ≈ expected exchange rate change Theoretical equilibrium, often imperfect
Conclusion
The USD/CAD pair is heavily influenced by oil prices, with a strong negative correlation due to Canada’s oil export dependence.
Interest rate differentials and central bank policies between the US and Canada also play a critical role, affecting bond yields and carry trade flows.
While carry trade strategies can amplify movements, they carry risk during market volatility.
Uncovered Interest Rate Parity provides a theoretical framework for exchange rate expectations but is often influenced by other market factors, including commodity prices and risk sentiment.
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