Canada’s GDP was flat quarter-on-quarter in the first quarter of 2026, following a 0.2% contraction in the fourth quarter of 2025, according to Statistics Canada. On an annualised basis, output fell 0.1%, compared with a market forecast for 1.5% growth. Momentum also weakened late in the quarter, with GDP contracting 0.1% in March on a monthly basis.
The Canadian dollar softened after the release. USD/CAD edged up 0.25% on the day to 1.3820 in the immediate reaction to the data.
Policy Outlook and Currency Implications
Given that Canada’s economy has stalled, we are adjusting our view on the Bank of Canada’s interest rate path for the remainder of the year. The market was caught off guard by the negative annualized GDP print, a stark contrast to the 1.5% growth that was expected. This surprise puts significant pressure on the central bank to consider easing monetary policy to stimulate growth.
We believe the Canadian dollar is positioned for further weakness against the US dollar in the coming weeks. With USD/CAD now trading above 1.3800, we see a clear path toward the 1.4000 level, especially as interest rate differentials are likely to move in favour of the greenback. Historically, during periods of economic underperformance like in 2020, the pair has shown it can move significantly higher in a short period.
Market Volatility, Positioning, and External Risks
The sharp miss in expectations is a clear signal to anticipate higher volatility in Canadian assets. One-month implied volatility for USD/CAD options has already risen from around 7% to over 8.5%, and we expect this trend to continue. We are looking to purchase USD/CAD call options to gain upside exposure while defining our risk in this uncertain environment.
We are also repositioning in the interest rate derivatives market to reflect a more dovish Bank of Canada. Overnight index swaps are now pricing in an over 80% probability of a 25-basis-point rate cut by the Bank’s July meeting. This is a dramatic shift from last week when the odds were below 20%, creating opportunities in instruments tied to Canadian short-term interest rates.
Finally, we must monitor external factors, particularly the price of oil, which is a key driver for the Canadian economy. With West Texas Intermediate crude currently trading below $80 a barrel, any further slide due to perceived weakness in global demand would compound the negative sentiment for the loonie. This commodity weakness would serve to reinforce our bearish Canadian dollar thesis.
