The US Dollar Breaks Out of Its Summer Rut

The widely followed DXY Index, which measures the US dollar’s value against other leading currencies, has risen recently and is now flirting with its summer highs. USDCAD has rallied to its highest level since April. This week’s US dollar strength is broad-based, with the greenback gaining ground across G10 and EM currencies. Several psychologically important levels have been breached, such as EURUSD falling below 1.15, AUDUSD below 0.65, and USDJPY and USDCAD settling well above 150 and 1.40, respectively.

The immediate catalyst for this breakout was last week’s shift in tone from the Federal Reserve, which leaned more hawkish than markets had anticipated. While the Fed kept the door open to further cuts, its messaging reinforced the idea that rates will decline more slowly than the market expects, and that inflation risks remain asymmetric.

But beyond the Fed, US economic outperformance is the underlying driver of the greenback’s strength. The US continues to outpace its peers when it comes to growth momentum, which is being supported by resilient consumption, stable labour markets, and robust investment, particularly in AI. This divergence in fundamentals is increasingly being reflected in FX markets.

Moreover, the greenback slowly clawed back its safe haven status over the summer. The clearest indication of this is the option risk reversal skew, which reflects traders’ expectations about which side of the distribution (USD up versus USD down) is likely to see the larger moves. This indicator now favours a stronger US dollar against most currencies, including the Canadian dollar. Moreover, the recent wobbles in stocks and precious metals have been correlated with a rising US dollar, which suggests that the greenback has reasserted its traditional safe haven status.

Canadian Dollar: Undervalued, but Not Ready to Recover

The Canadian dollar remains significantly undervalued on most fair value metrics. However, valuation alone is not enough. As we highlighted here External link., we expect CAD to remain weak over the next two quarters, on the back of softer domestic data, a relatively dovish Bank of Canada, and limited support from oil prices. While the loonie may eventually benefit from a narrower US-Canada growth differential in the latter half of next year, we expect no relief in the near term.  

Bottom Line

The US dollar’s breakout is both technically and fundamentally supported and may extend over the next few months. For CAD, undervaluation is a longer-term story—patience will be required before it can sustainably recover.