Barclays strategists pointed out in a recent research report that due to Canada's heavy dependence on the United States as its primary export market, a slowdown in the U.S. economy would pose significant downside risks to the Canadian economy. Under their baseline assumption of a U.S. soft landing, although cyclical currencies like the Canadian dollar (CAD) might gain some support, the CAD is expected to perform relatively weakly.
Barclays analysts explained that due to the Canadian economy's high sensitivity to changes in U.S. growth momentum, a slowdown in the U.S. economy will put greater economic pressure on Canada. This might force the Bank of Canada to adopt a relatively more dovish interest rate policy, thereby exerting further pressure on the CAD.
The research team predicts that once the Federal Reserve starts cutting interest rates, the performance of the CAD may deteriorate further. Additionally, there is a loose positive correlation between the CAD's trade-weighted exchange rate and the US dollar, which adds to the downside risk for the CAD in the future.
Barclays further stated: "As the Federal Reserve prepares its first rate cut, the market may reassess whether we are transitioning towards a hard landing, which will intensify the downside pressure on the CAD. Therefore, we recommend buying USD/CAD when it approaches 1.36."
Despite an increase in market confidence in recent weeks, with expectations that the Fed may begin cutting rates in September followed by multiple rate cuts thereafter, the U.S. economy is still perceived to be on a soft landing trajectory. If the U.S. economy indeed achieves a soft landing, the potential upside for USD/CAD would be maximized in a hard landing scenario, which could strengthen the CAD on a trade-weighted basis.
The Barclays team also noted: "Among all cyclical commodity currencies, the CAD has the lowest beta to risk-off shocks. This means that although a U.S. economic recession will have a direct negative impact on the Canadian economy, the CAD might outperform other cyclical commodity currencies in a hard landing scenario."
They added: "Under our baseline assumption of a soft landing, and considering the domestic economic backdrop in Canada as well as historical experience, the CAD is expected to underperform other cyclical commodity currencies."
Due to the close correlation between the CAD and the USD, GBP/CAD typically falls when USD/CAD rises, and conversely, rises when USD/CAD falls.
