Following the latest interest rate decision from the U.S. Federal Reserve, economists at TD Bank are predicting only one interest rate cut this year in the U.S. while adding the rate path could have implications for the loonie. 

In a report Thursday, Beata Caranci, the chief economist and senior vice president at TD Economics, and James Orlando, a director and senior economist at TD Economics, examined the trajectory of interest rates and the impacts on currencies. On Wednesday the Fed held its key rate at a two-decade high of around 5.3 per cent while saying inflation has remained stubbornly high. 

We have shifted our Federal Reserve call to only one rate cut this year due to the recent back-up of inflation that does not meet the Fed’s ‘confidence’ threshold to return inflation to two per cent in a timely manner,” the report said. 

In contrast, the economists expect the Bank of Canada to bring interest rates lower in the summer. As borrowing costs are expected to move lower in other countries relative to the U.S., the economists said the U.S. dollar would have “no challenger” until material changes occur in economic dynamics or geopolitics. 

However, according to the report, a rise in geopolitical risks would be expected to spur strength in the U.S. dollar. 

“The Canadian dollar is caught in the crosshairs. The Bank of Canada does not manage monetary policy with an eye on the loonie, but spreading interest rates too wide to its U.S. counterpart could cause a break below the resistance level of 72 U.S. cents,” the economists said. 

As peer economies have felt the weight of higher interest rates, Canada has posted a series of negative gross domestic product per capita figures over the past year, according to the report. 

The U.S. economy is on a “stronger footing than its peers” regarding economic and financial risks, the report said adding that it is also a net energy exporter. Additionally, as geopolitical risks rise investors “seek the shelter of U.S. dollar assets.” 

The loonie has been range bound between 72 and 76 cents U.S. beginning in the summer of 2022, according to the report, as the Fed’s interest rate hiking campaign closed the gap with the Bank of Canada’s and proceeded to move higher. 

“It also marked the time when the Canadian economy started to serially underperform the U.S. economy. Indeed, GDP per capita has been on the decline ever since,” the report said. 

The economists added that absent “unsustainable population growth,” the Canadian economy would have likely experienced a recession. 

Despite the population increase, economists expect first-quarter gross domestic product figures to be stronger due to a warmer winter. However, the report highlighted that job growth “has started to crack.”.  

“Growth in the number of unemployed workers is up 23 per cent over the last year, a level consistent with past recessions,” the report said. 

As a result of the softening economic environment, the economists expect an interest rate cut this summer from Canada’s central bank. 

“The BoC won’t want to get too far ahead of the Fed and risk undermining sentiment too much on the loonie. Rather, a further depreciation would likely be due to a risk-off move, potentially driven by an oil spike,” the economists said in the report. 

Going forward the economists said the Canadian dollar “could test at or below” 70 cents U.S. 

“Even though Canada is still an energy-focused economy, the marginal benefit from higher oil prices relative to the U.S. no longer exists for CAD,” the report said. 

“If geopolitical risks perk up in a way that presses oil prices higher, risk-off sentiment tends to dominate a depreciation in the currency relative to the nominal GDP benefits that flow through on the higher oil prices.”