Traders are the most bearish on the Canadian dollar in a year on expectations that Bank of Canada policymakers will telegraph interest-rate cuts when they announce their decision on Wednesday, or possibly even deliver a surprise easing.

Wells Fargo & Co., Monex Europe Ltd., Royal Bank of Canada and Bank of America Corp. are penciling in more weakness for the Canadian currency in the coming months relative to the U.S. dollar as they see the central bank turning more dovish on rates and signaling that it may move forward with earlier, deeper rate cuts than the Federal Reserve this year. 

Pricing in the options market suggests that traders are girding for more near-term volatility in the U.S.-Canadian dollar pair, with one-week risk reversals indicating that traders are the most negative on the Canadian dollar since March last year. At the same time, one-week and one-month volatility have hit their highest levels in three months. 

“We think there is a significant risk that markets will get a shock from the BOC,” Simon Harvey, chief analyst at Monex Europe, wrote in a note. He expects the Canadian currency to touch $1.39 per U.S. dollar by June, a level it last brushed up against in November. The currency traded around $1.3590 on Tuesday.

Markets are pricing in an 18 per cent possibility of a cut by the Bank of Canada, and the odds were as high as 21 per cent in the past week. Even if it keeps rates on hold as Monex Europe and other the banks expect, the Canadian currency risks further selling given that the central bank is already expected to cut more than Fed, and the cuts may run deeper. Traders are betting on around 68 basis points of cuts in Canada this year, compared with about 66 basis points expected by the Fed.

“Given the latest jobs and inflation data, we expect the BoC to open the door to a cut in June, which should put a bit more downside pressure on CAD,” said Erik Nelson, FX strategist at Wells Fargo. 

He added that there was room for a repricing in the pair to better reflect diverging rate differentials in the coming weeks, adding that a more significant and sustained break higher in the pair toward 1.40 would require a strong U.S. CPI print leading to a hawkish Fed.

Bank of America also expects the easing to begin in June, and is bearish on the Canadian currency versus the Australian dollar, while RBC expects the Canadian dollar to fall to $1.3750 per U.S. dollar in 2024 as markets price in more BOC cuts compared with the Fed.