Why Is the Canadian Dollar Falling?

Key Takeaways

• The Canadian dollar has been underperforming the US dollar since the onset of the Iran war.
• The loonie softness is largely due to US dollar strength rather than domestic fundamentals, according to analysts.
• Expectations of US Federal Reserve interest rate increases are amplifying the greenback’s strength.

With the Canadian dollar slumping against the US dollar, 2026 isn’t turning out the way many analysts expected. Coming into this year, forecasters had a strong outlook for the Canadian dollar, amid expectations of a healthy economy and Federal Reserve interest rate cuts in the United States. But the Iran war upended this. The Canadian economy is struggling, and investors now think the Fed could raise rates before 2026 is over. Not only that, but analysts say the US dollar has benefited from investors using it as a haven to mitigate war-related volatility.

The Canadian dollar was trading at C$1.39 against the US dollar on June 4, having fallen from C$1.35 just a week after the Iran war broke out on Feb. 28. A once-bullish outlook has turned dour. Analysts expect the loonie to continue to lag in the near term as economic resilience and expectations of higher-for-longer interest rates in the US continue to provide tailwinds for its currency.

The big picture is that the Canadian dollar’s fortunes are being driven more by US than Canadian dynamics, according to analysts. “We estimate around 85% of the move in [the Canadian dollar] has been driven by broader US dollar strength—due both to the rise in geopolitical risk and better-than-expected data [in the US],” says Sarah Ying, head of FX strategy at CIBC.

Currency analysts attribute only a limited share of the loonie’s recent weakness to domestic factors, such as a faltering labor market, slower GDP growth, and fading expectations for interest rate hikes at the Bank of Canada. Canada’s economy unexpectedly shrank in the first quarter, following a larger contraction in the fourth quarter of 2025, marking two consecutive quarters of negative economic growth. This is the technical definition of a recession.

The Loonie Lags as Iran War Jitters Fuel US Dollar’s Surge

The Canadian dollar started the year at C$1.37 against the US dollar, and it drifted higher to C$1.35 in February, boosted by growing expectations for a Bank of Canada rate hike and strong momentum in commodities, particularly gold. However, the script flipped when the Iran war erupted. War-driven oil price volatility prompted investors to seek refuge in the US dollar.

Nick Rees, head of macro research at Monex Canada, says that while the currencies of all the Group of 10 countries have slid against the US dollar, “the loonie is the worst-performing.”

Weaker Domestic Economic Data

Analysts say that some of the loonie’s weakness comes from concerns that domestic economic growth is being held back by a softening labor market and an uptick in inflation. “Relatively soft economic data early in May contributed to underperformance,”says Tom Nakamura, currency strategist and co-head of fixed income at AGF Investments.

The Canadian economy lost 18,000 jobs in April, and the unemployment rate jumped to 6.9% from 6.7% the month before, signaling labor market softness. Meanwhile, Canada’s inflation spiked for a second consecutive month in April, fueled by war-driven higher oil prices.

In contrast, the US economy has shown signs of resilience, according to CIBC’s Ying. “Recent data suggests the American job market has stabilized, and inflation is running a bit higher than expected, partly because of rising energy costs,” she says.

Divergent Central Bank Rate Paths

With the Canadian economy softening and the US economy remaining healthy (though with high inflation), the outlook for monetary policy in both countries is heading in opposite directions.

The oil shock from the Iran war “has created some material concern that persistent inflation could not only prevent the Fed from cutting rates, but also compel it to hike rates to moderate inflation expectations,” says AGF’s Nakamura, who adds that this has helped drive up the US dollar.

Meanwhile, inflation in Canada has been showing signs of cooling, evidenced by core CPI (which excludes food and energy) hovering around 2%. “While higher energy prices could push core inflation up slightly, we don’t see an urgent need for the Bank of Canada to raise interest rates this year,” says CIBC’s Ying.

Moreover, weaker domestic economic fundamentals—a softer labor market and another quarter of GDP contraction—“will weigh against the Bank of Canada hiking prospects,” says Monex’s Rees.

The resulting higher rates in the US and steady rates in Canada “tend to strengthen the US dollar against other currencies, including the Canadian dollar,” Ying says.

What Needs to Change to Lift the Loonie?

For the Canadian dollar to reverse its course and close the gap with the US dollar, analysts say that certain catalysts must materialize. The Canadian dollar could appreciate if “the Strait of Hormuz opens, with the expectations that it will remain open and [the West Texas Intermediate crude oil price] normalizes to USD 80-USD 85,” says CIBC’s Ying. Other potential key drivers include deteriorating US employment data, which would require the Fed to ”remain patient for longer,” or certainty about the Canada-United States-Mexico Agreement.

Monex’s Rees says the Canadian dollar could see a reprieve in the third quarter, when he expects domestic economic indicators to improve, following a resolution to the war in the Middle East and greater clarity around the trade deal with the US. “At that point, we see a solid case for loonie gains, with the economy starting from a weaker base, meaning greater scope for improving data to fuel the Canadian dollar upside,” he says.