Investors wondering why the Canadian dollar isn’t rallying along with the oil price will find their answer in the accompanying charts. In short, bond yields are driving the loonie’s value, not commodity prices.
The first chart below compares the value of the domestic dollar against the two-year bond spread – the difference between the government of Canada two-year bond yield and the two-year U.S. Treasury yield. The two lines in the chart are tracking closely and the strong relationship is supported by correlation calculations. (The coefficient of correlation, which measures the degree of association between two data sets and ranges from -1 to +1, is very high at 0.89).
The currency’s connection with relative bond yields lies with the desirability of Canada as an investment destination for foreign capital. When domestic bond yields are much higher than U.S. yields, global fixed income investors exchange their currency into loonies to buy the bonds, pushing the loonie higher. When Canada is growing quickly, and this growth is reflected in higher bonds yields, Canadian assets in general are attractive to international investors, and the loonie is in demand in foreign exchange markets.
Loonie moving more with bond spreads …
CADUSD
2YR GoC Bond Yld minus 2YR UST Yld
$0.82
1.0
0.80
0.5
0.78
0.0
0.76
-0.5
0.74
0.72
-1.0
0.70
-1.5
0.68
-2.0
0.66
-2.5
0.64
0.62
-3.0
‘21
2022
2023
2024
2025
2026
… than crude prices
West Cda. Select Crude (US$/bbl)
CADUSD
$0.83
$120
0.81
100
0.79
0.77
80
0.75
60
0.73
0.71
40
0.69
20
0.67
0.65
0
‘21
2022
2023
2024
2025
2026
the globe and mail, source: bloomberg
Loonie moving more with bond spreads …
CADUSD
2YR GoC Bond Yld minus 2YR UST Yld
$0.82
1.0
0.80
0.5
0.78
0.0
0.76
-0.5
0.74
0.72
-1.0
0.70
-1.5
0.68
-2.0
0.66
-2.5
0.64
0.62
-3.0
‘21
2022
2023
2024
2025
2026
… than crude prices
West Cda. Select Crude (US$/bbl)
CADUSD
$0.83
$120
0.81
100
0.79
0.77
80
0.75
60
0.73
0.71
40
0.69
20
0.67
0.65
0
‘21
2022
2023
2024
2025
2026
the globe and mail, source: bloomberg
Loonie moving more with bond spreads …
CADUSD
2YR GoC Bond Yld minus 2YR UST Yld
$0.82
1.0
0.80
0.5
0.78
0.0
0.76
-0.5
0.74
0.72
-1.0
0.70
-1.5
0.68
-2.0
0.66
-2.5
0.64
0.62
-3.0
‘21
2022
2023
2024
2025
2026
… than crude prices
West Cda. Select Crude (US$/bbl)
CADUSD
$0.83
$120
0.81
100
0.79
0.77
80
0.75
60
0.73
0.71
40
0.69
20
0.67
0.65
0
‘21
2022
2023
2024
2025
2026
the globe and mail, source: bloomberg
The second chart shows the relationship between the Canadian dollar and the Western Canada Select Crude price. The two lines move only roughly in the same direction – U.S. dollars are still exchanged into loonies after the oil is bought – but the correlation calculations verify a much lower degree of association between the two data sets than in the first chart. The coefficient of correlation is 0.50.
It’s true that correlation does not prove causation but it’s also clear that the loonie’s value is much more associated with bond yields than the oil price in recent months. Things can change without warning but for me the market’s emphasis on bond yields goes a long way to explaining why high global oil prices are not turning into a higher Canadian dollar.