Loonie falls further after U.S. Fed rate cut. Here’s what’s happening

The Canadian dollar’s slide continued Wednesday amid expectations for a slower pace of rate cuts from the U.S. Federal Reserve.

The Federal Reserve cut its key interest rate Wednesday by a quarter-point — its third cut this year — but also signaled that it expects to reduce rates more slowly next year than it previously envisioned, largely because of still-elevated inflation.

The Fed’s 19 policymakers projected that they will cut their benchmark rate by a quarter-point just twice in 2025, down from their previous estimate in September of four rate cuts.

1:37 How Loonie dropping below 70 cents U.S. could impact Canadian finances

The Canadian dollar fell roughly half a cent compared to its U.S. counterpart after the Fed decision Wednesday. The loonie was trading around 69.3 cents US as of 4 p.m. Eastern, just a day after crossing the 70-cent threshold for the first time since March 2020.

A widening gap between the Bank of Canada and the U.S. Fed’s policy rates is typically bad news for the loonie, explains Rahim Madhavji, president of Knightsbridge Foreign Exchange, a currency exchange based in Toronto.

The Bank of Canada got a headstart on its interest rate easing cycle amid earlier success taming inflation and signs of weakness in the Canadian economy. It has cut 1.75 per centage points from its policy rate this year, compared to just 75 basis points of easing from the U.S. Fed.

While the Bank of Canada has signalled that its pace of cuts will also slow in 2025, the news that the Fed was slashing its own forecast for next year meant that gap will likely persist.

1:48 Bank of Canada cuts rates by half a point but signals ‘more gradual’ pace

Madhavji told Global News on Wednesday that investors are more likely to park their money in an economy with higher interest rates in hopes of a better return.

“Interest rates attract investment,” he said. “And if we’re cutting rates faster and steeper here than that of the United States, you’re going to see money move from Canada into the U.S., or net new money not come into Canada as a result of that.”

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The loonie has been on a downward slide for much of 2024, but the pace of the decline picked up after the re-election of Donald Trump in November. His threats of tariffs on Canadian goods crossing into the States and the political turmoil it has spurred north of the border are similarly bad for the loonie, Madhavji said.

“At the end of the day, the Canadian dollar moves in the direction of the Canadian economy,” he said.

And while recent developments have been largely sour for the Canadian outlook, Madhavji also noted that other currencies around the world are struggling to keep up with the surging American greenback.

“Because the U.S. economy has been doing better and the expectation is that it’s going to do better with the new administration and some deregulation and a focus on the economy, that’s why you’ve seen the U.S. dollar have so much strength.”

The U.S. Fed’s new quarterly projections suggest that consumers may not enjoy much lower rates next year for mortgages, auto loans, credit cards and other forms of borrowing.

Fed officials have underscored that they are slowing their rate reductions as their benchmark rate nears a level that policymakers refer to as “neutral” — the level that is thought to neither spur nor hinder the economy. Wednesday’s projections suggest that policymakers may think they are not very far from that level. Their benchmark rate stands at 4.3 per cent after Wednesday’s move, which followed a steep half-point reduction in September and quarter-point cut last month.

This year’s Fed rate reductions have marked a reversal after more than two years of high rates, which largely helped tame inflation but also made borrowing painfully expensive for American consumers.

But now, the Fed is facing a variety of challenges as it seeks to complete a “soft landing” for the economy, whereby high rates manage to curb inflation without causing a recession. Chief among them is that inflation remains sticky: According to the Fed’s preferred gauge, annual inflation was 2.8 per cent in October, the same as in March and still persistently above the central bank’s two per cent target.

At the same time, the economy is growing briskly, which suggests that higher rates haven’t much restrained the economy. As a result, some economists — and some Fed officials — have argued that borrowing rates shouldn’t be reduced much more for fear of overheating the economy and re-igniting inflation. On the other hand, the pace of hiring has cooled significantly since 2024 began, a potential worry because one of the Fed’s mandates is to achieve maximum employment.

3:07 Poilievre says Bank of Canada forced into ‘panicked rate cut’ by Trudeau economy

The unemployment rate, while still low at 4.2 per cent, has risen nearly a full percentage point in the past two years. Concern over rising unemployment contributed to the Fed’s decision in September to cut its key rate by a larger-than-usual half point.

On top of that, President-elect Donald Trump has proposed a range of tax cuts — on Social Security benefits, tipped income and overtime income — as well as a scaling-back of regulations. Collectively, these moves could stimulate growth. At the same time, Trump has threatened to impose a variety of tariffs and to seek mass deportations of migrants, which could accelerate inflation.

Chair Jerome Powell and other Fed officials have said they won’t be able to assess how Trump’s policies might affect the economy or their own rate decisions until more details are made available and it becomes clearer how likely it is that the president-elect’s proposals will actually be enacted. Until then, the outcome of the presidential election has mostly heightened the uncertainty surrounding the economy.

“I’ve got the least amount of conviction about what will happen with the economy over the next 12 months than I’ve had in years,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale. “This is going to be a work in progress as things evolve.”

Most other central banks around the world are also cutting their benchmark rates. Last week, the European Central Bank lowered its key rate for the fourth time this year to three per cent from 3.25 per cent, as inflation in the 20 countries that use the euro has fallen to 2.3 per cent from a peak of 10.6 per cent in late 2022.

Beth Hammack, president of the Federal Reserve Bank of Cleveland, dissented from Wednesday’s Fed decision because she preferred to keep rates unchanged. It was the first dissent by a Fed committee member since September.

— with files from Global News’s Anne Gaviola and The Associated Press