The Bank of Canada is on hold and the U.S. Federal Reserve is set to cut interest rates. A stronger Canadian dollar is the inevitable result.
Central banks on both sides of the border provided monetary-policy guidance Wednesday, with decidedly different perspectives. In the United States, Fed chairman Jerome Powell “all but guaranteed that the Federal Open Market Committee will cut rates at its meeting in late July,” according to TD senior economist James Marple.
Domestically, Royal Bank of Canada’s view was that “[BoC Governor Stephen] Poloz and Co. still don’t appear to be in any rush to lower rates alongside the Fed.”
Shorter-term government bond yields take their cues from central banks and have also, in recent years determined the value of the Canadian dollar.
The accompanying chart shows the power of relative bond yields – specifically the difference between the government of Canada two-year bond yield and the equivalent U.S. Treasury bond yield – to drive the value of the loonie.
BOND SPREAD NARROWING,
LOONIE RISING
CAD/USD (left scale)
Two-year spread: Two-year Canadian bond
yield minus two-year U.S. Treasury yield
(right scale, %)
$1.00
0.9%
0.7
0.95
0.5
0.90
0.3
0.1
0.85
-0.1
0.80
-0.3
-0.5
0.75
-0.7
0.70
-0.9
0.65
-1.1
2014
2015
2016
2017
2018
2019
CARRIE COCKBURN / THE GLOBE AND MAIL,
SOURCE: BLOOMBERG, SCOTT BARLOW
BOND SPREAD NARROWING, LOONIE RISING
CAD/USD (left scale)
Two-year spread: Two-year Canadian bond yield minus
two-year U.S. Treasury yield (right scale, %)
$1.00
0.9%
0.7
0.95
0.5
0.90
0.3
0.1
0.85
-0.1
0.80
-0.3
-0.5
0.75
-0.7
0.70
-0.9
0.65
-1.1
CARRIE COCKBURN / THE GLOBE AND MAIL,
SOURCE: BLOOMBERG, SCOTT BARLOW
2014
2015
2016
2017
2018
2019
BOND SPREAD NARROWING, LOONIE RISING
CAD/USD (left scale)
Two-year spread: Two-year Canadian bond yield minus
two-year U.S. Treasury yield (right scale, %)
$1.00
0.9%
0.7
0.95
0.5
0.90
0.3
0.1
0.85
-0.1
0.80
-0.3
-0.5
0.75
-0.7
0.70
-0.9
0.65
-1.1
2014
2015
2016
2017
2018
2019
CARRIE COCKBURN / THE GLOBE AND MAIL, SOURCE: BLOOMBERG, SCOTT BARLOW
The blue line represents the two-year yield spread – the yield of the domestic bond minus the yield on the U.S. bond. The measure has tracked the value of the loonie extremely closely over the past five years.
From late May, 2019, the two-year spread between Canadian and U.S. bonds has narrowed from 62 basis points (0.62 per cent) to the current 26 basis points. At the same time, the Canadian dollar has appreciated 4 per cent in U.S. dollar terms, from 74 US cents to 77 US cents.
Mr. Poloz’s signalling of no intention to cut rates and Mr. Powell’s indication of an imminent rate reduction in their Wednesday remarks merely exacerbated current trends in bond yields. All signs now point to higher domestic bond yields relative to U.S. yields (a rising blue line on the chart) and a stronger loonie.
Scott Barlow