Why Is the CAD So Weak? Key Factors Explained

The Canadian dollar (CAD), often referred to as the “loonie,” plays a central role in Canada’s economic landscape. Its value, determined by supply and demand in foreign exchange markets, significantly influences the cost of imports and the competitiveness of exports. The CAD’s current weakness stems from interconnected global and domestic forces, which this article will explore.

Understanding Interest Rate Differences

Differences in interest rates between countries significantly influence currency values by affecting capital flows. When the Bank of Canada (BoC) sets its benchmark interest rate lower than other major central banks, particularly the U.S. Federal Reserve (Fed), it creates an interest rate differential. This differential means that investments in Canada may offer lower returns compared to those in countries with higher rates. Consequently, foreign investors seeking better yields may move their capital out of Canada and into economies offering more attractive returns, increasing demand for foreign currency and decreasing demand for the CAD.

Higher U.S. interest rates make dollar-denominated assets more appealing to investors, increasing demand for U.S. dollars and leading to its appreciation against the Canadian dollar. A wider interest rate gap intensifies this effect, as the incentive for capital to flow out of Canada grows. While both central banks influence their respective currencies, a prolonged divergence in monetary policy, where the BoC’s rates are considerably lower, consistently favors the U.S. dollar and puts downward pressure on the CAD.

Influence of Commodity Prices

Canada’s economy is heavily reliant on its natural resources, making the Canadian dollar often behave as a “petrocurrency.” A substantial portion of Canada’s exports are tied to commodities such as crude oil, natural gas, and metals, with crude oil exports alone accounting for approximately 10% of Canada’s Gross Domestic Product (GDP). Global commodity price fluctuations have a direct impact on the value of the CAD.

When global commodity prices, especially oil, decline, Canada’s export revenues decrease. This reduction in foreign currency earnings, particularly U.S. dollars, lessens demand for the Canadian dollar, leading to its depreciation. Conversely, rising commodity prices generally strengthen the CAD because increased export revenues boost foreign demand for the currency. The volatility in oil prices, influenced by global supply, demand, and geopolitical tensions, creates a structural vulnerability for the Canadian dollar, particularly during economic uncertainty.

Canada’s Domestic Economic Performance

The health of Canada’s internal economy plays a significant role in influencing the Canadian dollar’s value. Key economic indicators such as Gross Domestic Product (GDP) growth, inflation rates, employment figures, and consumer spending provide insights into the country’s economic strength and attractiveness to investors. A robust domestic economy, characterized by solid GDP growth and low unemployment, tends to support a stronger currency. For example, Canada’s GDP expanded by 0.50 percent in the first quarter of 2025 over the previous quarter, and by 2.30 percent year-over-year.

Conversely, signs of a weaker domestic economy, such as slower growth or higher unemployment, can signal fewer investment opportunities, making the CAD less attractive. A sustained period of economic underperformance can lead to reduced foreign investment and capital flight, further weakening the currency. Inflation rates also factor into this dynamic; while the Bank of Canada aims to maintain inflation within a target range of 1% to 3%, persistent deviations can influence monetary policy decisions and, consequently, the CAD. The overall sentiment regarding Canada’s economic outlook, derived from these indicators, directly impacts investor confidence and their willingness to hold Canadian dollar assets.

Global Economic Environment and US Dollar Strength

Broader global economic conditions and the strength of the U.S. dollar exert considerable influence on the Canadian dollar. In times of global economic uncertainty or heightened risk aversion, investors often seek “safe-haven” assets to protect their capital. The U.S. dollar is widely considered a safe-haven currency due to the size and stability of the U.S. economy and its financial markets. This “flight to safety” can lead to increased demand for the U.S. dollar, causing it to strengthen against other currencies, including the CAD, even if Canada’s domestic conditions are relatively stable.

Geopolitical events and global trade tensions can further amplify this effect by increasing investor uncertainty and impacting confidence in riskier assets. For example, tariffs or the threat of trade wars can disrupt global commerce, leading to fewer U.S. dollars flowing into Canada and weakening the CAD. The U.S. dollar’s dominance in global financial markets, accounting for a significant portion of foreign exchange transactions and official reserves, means its strength can disproportionately affect currencies like the CAD, regardless of Canada’s specific economic fundamentals.