The Bank of Canada may part ways with the Federal Reserve, and the currency market is unpredictable

foreign exchange documentary platformTraders are bracing for a weaker Canadian dollar amid bets that local policymakers could cut rates before Federal Reserve officials.

Some on Wall Street expect spreads to widen when the Bank of Canada meets on Wednesday - already making the Canadian dollar one of the worst performers in the G10 group of currencies this quarter. The Canadian dollar has been the second-worst performer in the G10 group since the end of March, behind the Japanese yen.

"A rate cut by the Bank of Canada will put pressure on the Canadian dollar," said Elias Haddad, a senior strategist at BrownBrothersHarriman. He shared the expectations of many on Wall Street that the Bank of Canada would soon cut rates, while US data could force Federal Reserve officials to keep rates high for longer.

For many foreign exchange traders, that means the CAD/USD exchange rate could continue to fall regardless of whether Canada cuts rates in June or July. Markets are pricing in a roughly 80% chance of a rate cut on Wednesday, compared with a 60% chance before last week's lower-than-expected GDP data.

Recent data from the US Commodity Futures Trading Commission showed that bearish bets on the Canadian dollar by asset managers and hedge funds remained at a near seven-year high, with only modest reductions in positions.

"Even without a rate cut, the Canadian dollar is unlikely to see a sustained short-term rally," said Howard Du, FX strategist at Bank of America. "With the Bank of Canada looking to lay the groundwork for a rate cut in July, their communication or guidance will likely remain dovish."

A series of technical signals also sounded the alarm. Weekly options volatility, which includes this week's US and Canadian jobs data, hit 6.07% on Tuesday, its highest level in more than a month.

Volume of US-Canadian calls has outstripped that of puts by about three to two over the past week as the likelihood of a rate cut by the Bank of Canada has increased, according to Depository Trust and Clearing Corporation. Twenty per cent of the calls traded have a strike price of 1.40 or more - the weakest level the Canadian dollar last broke through in 2020.

Shaun Osborne, chief FX strategist at Scotiabank, one of the few banks to keep rates on hold, said that while traders were still actively shorting the Canadian dollar "unless there is a new or additional incentive to go further", the dollar's decline would be limited even if rates were cut.

Veronica Clark, an economist at Citi, also expects rates to remain unchanged this week. "The pick-up in US inflation after six to seven consecutive months of good performance could be a particular warning against premature rate cuts," she wrote in a note to clients on Monday. "We continue to expect the first rate cut in July."

Some advocates of the June rate cut believe the Canadian dollar will regain some strength later this year, when the Federal Reserve may cut interest rates to narrow the gap with the Bank of Canada.

Howard Du, Bank of America, expects the Canadian dollar to rise to 1.35 by the end of the year as US inflation and growth data continue to follow Canada lower, "and the Canadian dollar/dollar should rise even more sharply once a Fed rate cut is imminent."