The Canadian economy slowed in August and appears to have contracted in September, endangering hawkish expectations for the Bank of Canada’s policy trajectory. Numbers released by Statistics Canada this morning showed real gross domestic product flatlining in month-over-month terms in August, undershooting market expectations – and the agency’s own preliminary estimate – for a 0.2% gain. On a year-over-year basis, activity rose 1.5%, below the expected 1.7%.

A number of potentially short-lived factors drove the weakness, but momentum faded nonetheless. A decline in wholesale trade, led by softness in auto sales, was the biggest contributor to the soft headline, followed by a drop in energy and utilities output — likely related largely to maintenance shutdowns — and a steeper-than-expected decline in the public sector. These factors should fade. But only nine of 20 subsectors expanded in August, and an advance estimate showed the economy contracting 0.1% in September, putting real activity on track for annualised growth of 1.3% in the third quarter, down from 3.8% in the previous three months.

The data shows Canada is still underperforming the US. Reports published yesterday showed the US economy expanding at an annualised 3.4% pace in the third quarter, underpinned by strong household consumption, an inventory build, and the artificial intelligence buildout. Forecasters expect the US to grow roughly 2.3% this year, against 1.0% in Canada.

The Canadian economy has nonetheless proved far more resilient than many expected during the initial onslaught of tariff increases last year. Exports as a whole have strengthened despite continued weakness in tariff-hit sectors, thanks to robust American demand, higher energy production, and mounting evidence that businesses are adapting to the new trading environment. Consumer spending has held up, business investment is expanding, and unemployment has remained surprisingly steady. Most observers expect momentum to accelerate over the year ahead, with the cross-border growth gap narrowing as domestic tailwinds strengthen.

The Canadian dollar is giving back early gains as interest rate differentials widen incrementally against it. Overnight index swap traders are slightly lowering the odds on another hike at the Bank of Canada’s December meeting, but still expect a total of three moves by next September, almost unchanged from pre-release levels.

Currency markets may be buffeted by mild crosswinds in the hours ahead. Fed officials are emerging from their post-meeting blackout, with Thomas Barkin and Mary Daly scheduled to speak, along with Alberto Musalem. Still-elevated oil prices and weakness in the AI complex are weighing on risk appetite. And traders may also take some risk off the table, trimming both long and short positions ahead of next week’s midterms – even if few expect the outcome to produce decisive moves in either direction. Absent new geopolitical catalysts, we think the US dollar should remain on the defensive against this backdrop.