A major divergence in bond and currency markets suggests that, either the Canadian dollar is set for a sharp fall, or five-year bond yields are set to climb. Canadian homeowners should be hoping for a weaker loonie.
The chart below illustrates the important role of government bond yields in determining the value of the domestic currency. The black line shows the spread between Canadian and U.S. five year bond yields plotted against the value of the loonie (red line). The correlation using three years of daily data is exceedingly high at 0.86 (R-squared 0.74).