Canada Best Ideas 2026: Get Ready to Diverge

What You Need to Know:

• Canada and the U.S. may follow different economic and interest-rate paths into 2027.
• The Canadian dollar may weaken near term, then recover as policy paths converge.
• The Bank of Canada is expected to remain on hold longer than markets anticipate.
• Global resilience and a weaker U.S. dollar could support the loonie despite limited help from resource prices.

Canada Best Ideas is an annual compilation of our highest-conviction investment ideas across our Canadian coverage universe. Our Canadian and U.S. Macro Research teams also contribute key themes related to the macroeconomic outlook in Canada.

We firmly believe that bringing an integrated North American perspective is a crucial element to successfully investing in the Canadian market, and we are well positioned to help our clients benefit from our North American presence and collaborative culture.

The TD Cowen Insight

We see divergence from the U.S. as a key theme to the Canadian economic and FX outlook heading into 2027.

Summary Of Our Thesis

We expect some near-term underperformance in the Canadian Dollar (CAD) as interest rate differentials move in favor of the U.S. and CAD's appeal as a carry funding currency rises. However, we expect CAD to recover in 2027 as policy paths converge, fiscal stimulus begins to feed through and the bearish U.S. dollar (USD) regime returns.

Economics - What Is Underappreciated or Misunderstood?

Near-term Bank of Canada pricing looks increasingly misaligned with the domestic backdrop as we see limited evidence of high oil prices broadening into core inflation. Markets have continued to price in a similar near-term path for the Bank of Canada (BoC) and U.S. Federal Reserve (Fed) despite a divergence in the two economies. Elevated trade uncertainty should also help keep the BoC on hold into 2027, even if U.S tariffs have not had much of a lasting impact outside targeted sectors.

A hawkish Fed alone does not necessarily translate into a stronger dollar. Sustained gains require the Fed to out-hawk both the market and peer central banks, alongside a return of U.S. exceptionalism. Moreover, while U.S. assets continue to attract foreign investors, increasing global capital allocations into rest of the world (ex-U.S.A.) are diluting the demand for the greenback.

What Is the Bear Case and The Risks to Our Call?

A rapid broadening of inflation pressures or geopolitical escalation are the main risks to increased divergence between the BoC and Fed. However, inflation pressures have not broadened through August, and inflation expectations remain well anchored. Stronger domestic activity or more fiscal stimulus could also pull the BoC off the sidelines sooner.

Canada-U.S. relations have been tested by the pivot in U.S. trade policy, but Canada's links to the U.S. economy were already starting to fray before the recent increase in trade tensions. Non-energy export volumes have been stagnant for nearly two decades, and Canada's share of U.S. imports has fallen by nearly 5pp since the Global Financial Crisis. Part of this reflects offshoring impacts in the U.S.; as more industrial production moves offshore, Canadian supply chains will play a smaller role. The U.S. remains by far the largest individual market for Canadian exports, and goods exports still account for ~25% of real GDP. However, Canada has shown less sensitivity to U.S. demand or a softer loonie as a driver for growth over the last two decades.

Non-Energy Export Volumes Have Seen Little Growth Over Last Two Decades

Tariff Impacts on Manufacturing Have Been Concentrated Across 232-Targeted Sectors

Domestic Issues on the Backburner

With the ongoing focus on geopolitics and U.S. trade policy, domestic issues like immigration policy and household leverage are not getting the same level of attention. That is understandable. Canadian immigration policy has not changed substantively since the gears to reduce temporary residents were first put in motion over 2024. Canada has now seen six quarters of outflows for temporary residents and three consecutive quarters of negative population growth. Temporary residents account for 6.2% of the population in Q2, but on this trajectory the government should hit the 5% target by the end of 2027.

Federal Government is Getting Closer to its Target for Temporary Residents

FX Implications

U.S.-Canada policy divergence began with the September meetings. We expect Fed to deliver a total of 75bps over the cycle—ending in January 2027— just when we forecast BoC to start tightening in our base case. With a follow-up move in March, we see the Canadian terminal rate at 2.75%, leaving the U.S.-Canada policy gap 25 bps wider. Higher U.S. rates in 2026 and any potential Fed hikes can force a partial capitulation of the bearish dollar positioning, but the gains are likely to be episodic rather than trend-like. We expect dollar weakness to resume after midterm elections and USD gains from any Fed hikes to be fairly limited as we stay in an overarching bearish dollar regime. Accordingly, we expect some near-term USD strength and expect USDCAD to hover around 1.40 before it starts to head lower towards the end of 2026 and through 2027.

Global Resilience

So far, the global economy appears to be absorbing tariff uncertainty and the renewed oil-price shock better than initially feared. There has been limited evidence of a material deterioration in demand, employment or business confidence. With global growth holding up, markets are treating current risks as carry opportunities rather than catalysts for a flight to safety.

The U.S. now needs a much larger growth advantage than the rest of the world to generate the same degree of dollar strength. Recently, the dollar materially underperformed what growth differentials would have implied in 2025, and we are not observing the U.S. exceptionalism that characterized 2022-2023.

Why the Resource Rally Isn’t Fueling CAD

Rising energy and metals prices have supported Canada's trade balance and extended the improvement in its terms of trade (ToT). However, we remain cautious on any support to the Canadian Dollar from that channel. Higher energy prices have significantly boosted Canada's ToT in the last few years, but this has failed to translate into meaningful CAD strength.

If we look at the explanatory power of oil prices in weekly CAD returns, it has continued to decline in the last decade. Intuitively, supply-side shocks are unpredictable and volatile and hence unlikely to drive investment decisions. New investment in the oil and gas sector has been on the decline since 2014, with the big ToT shock of 2022 failing to meaningfully buck the trend. We have started to see a pickup in the sector only recently, but as a percentage of total capex, the investment in the sector remains modest.

Rising energy and metals prices have helped improve Canada's trade balance