Energy-driven inflation risks complicate central bank moves as CAD outlook improves
A fresh report from TD Economics suggests that a renewed energy shock is complicating the interest rate outlook, even as the Canadian dollar is poised to strengthen modestly.
In its latest “Dollars and Sense” publication, the firm points to geopolitical tensions—particularly those impacting oil markets—as a key force pushing inflation risks higher and keeping bond yields elevated. The result is a more uncertain path for central banks navigating rate decisions.
The commentary from economists Thomas Feltmate and Andrew Hencic notes that persistent inflation concerns are still embedded in bond markets, with yields remaining above pre-crisis norms due to uncertainty around how quickly price pressures will ease.
They argue that if rate cuts materialize later this year, that inflation premium should gradually unwind. This would pull long-term yields lower and, in turn, weaken the US dollar.
That dynamic is expected to benefit the Canadian currency.
According to the report, “a further narrowing of interest rate differentials vis-à-vis other advanced economies should work to put a bit more downward pressure on the dollar,” with the loonie positioned to rise alongside it.
TD sees the Canadian dollar gaining roughly 1.3 cents by year-end, bringing it to around 74 US cents, a level not reached since late 2024.
However, the path forward is far from straightforward.
The report highlights that a prolonged energy disruption could keep inflation elevated for longer than expected, delaying central bank easing and keeping yields higher in the near term. Under such a scenario, U.S. 10-year Treasury yields could climb further before gradually easing back.
For advisors, the takeaway is a market environment still heavily influenced by geopolitical developments and inflation volatility. While currency appreciation may offer some upside for Canadian investors, the timing and trajectory will depend largely on how central banks respond to evolving inflation risks.
TD Economics emphasizes that the balance between inflation pressures and monetary policy easing will remain the key driver for both bond markets and currency movements in the months ahead.
