Market Brief: FX Momentum Dies As Fed Officials Outline Dual-Sided Risks

After most Federal Reserve officials—with the notable exception of Stephen Miran—sounded a consistently-cautious and incrementally-hawkish tone in appearances during the early part of the week, the US dollar is staging a recovery against its major peers—including the euro, pound, yen, and Canadian dollar—Treasury yields are moving sideways, and North American equity futures are setting up for small gains at the open.

Federal Reserve chair Jerome Powell didn’t rock any market boats in yesterday’s economic outlook speech. Speaking in Providence, Rhode Island, he noted that both ends of the central bank’s dual inflation and employment mandate are moving in the wrong direction, implying that last week’s rate cut shouldn’t be viewed as the beginning of a prolonged easing cycle, and saying “When our goals are in tension like this, our framework calls for us to balance both sides of our dual mandate”. “Two-sided risks mean that there is no risk-free path,” he warned, “If we ease too aggressively, we could leave the inflation job unfinished and need to reverse course later to fully restore two percent inflation. If we maintain restrictive policy too long, the labour market could soften unnecessarily”. Traders still see policymakers bringing the Fed Funds rate down to roughly 3 percent by the end of 2026, essentially unchanged from where expectations sat at the end of April.

Here in Canada, there was no apparent currency market reaction to yesterday’s speech from Tiff Macklem on “Global trade, capital flows, and Canada’s prosperity”. The Bank of Canada governor outlined four “megatrends” impacting the world economy—slowing trade, the emergence of China and Europe as major trade hubs, continued US domination of international capital flows, and persistent global imbalances—and warned that monetary and fiscal policy changes alone can’t offset the impact that the Trump administration’s tariffs might have on the domestic economy. Instead, he argued, Canada should work to lower interprovincial trade barriers, reduce regulatory burdens, and build better transportation links so that the country becomes more productive, more attractive from an investment standpoint, and more competitive on global markets.

Outside the greenback, the Canadian dollar remains the worst-performing major currency this year. Structural headwinds—including persistently-low productivity, overreliance on exports to the US, elevated levels of household debt, and extreme housing market vulnerabilities—have combined to put the currency under consistent selling pressure, even as its counterparts in Europe, the United Kingdom, and elsewhere have strengthened.

We think this dynamic will remain in place through year end as growth remains moribund, unemployment stays high, and growing demand-side slack combines with the government’s recent reduction in retaliatory tariffs to drive an easing in inflation pressures. The Bank of Canada seems likely to deliver at least one more rate cut, and could communicate its willingness to lower policy further into neutral territory if needed, but with at least four rate cuts already priced in for the Fed against one for the Bank of Canada over the next year, changes in interest rate differentials alone are unlikely to generate the momentum needed to break the dollar-Canada pair out of the technically-reinforced 1.3550-1.3800 trading range that has held since July. Further, we think the greenback itself should firm slightly over the coming months as incoming data points to ongoing resilience in the world’s largest economy.

There are reasons to suspect that the loonie could begin to recover in the early part of next year, however. The Carney government could ramp up fiscal stimulus and propose pro-competitive improvements in tax policies in early November, helping to boost expectations for growth in 2026. Trade uncertainties could gradually resolve themselves in the run-up to a new agreement by mid-year, leaving the US tariff rate on Canadian exports low relative to other major economies. And the US dollar itself could lose ground again as the lagging impact of this year’s policy changes begins to hit home. A move back into the low 1.30’s by the end of 2026 doesn’t seem improbable.

Volatility in major currency pairs remains strikingly subdued. While headlines around Japanese politics, French fiscal strains, and Britain’s funding challenges continue to generate short-term fluctuations, broader drivers of turbulence have receded. The “tail risks” that loomed during the opening months of the second Trump administration have receded in the minds of investors, central banks are broadly adhering to previously expected policy paths, and financial conditions remain deeply accommodative. Trading ranges have compressed, shocks have become smaller and shorter-lived, and implied volatility expectations have come down. This is unlikely to last, given the number of contradictions currently embedded in market expectations, and—at the risk of talking our book—we would urge corporate hedgers to think about beginning to implement their 2026 strategies now, while complacency levels are high, and insurance is relatively cheap.

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