Canadian dollar climbs to five-month high as yield gap vs U.S. slides

The Canadian dollar strengthened to a near five-month high against the greenback on Thursday as the additional return on holding U.S. bonds fell to the lowest in more than one year.

The gap between Canada’s 2-year yield and its U.S. equivalent, which was 84 basis points in March, narrowed by 1.7 basis points to less than 30 basis points in favour of the U.S. bond, its smallest differential since February 2018.

The narrowing in the yield differential comes after the Federal Reserve shifted from hiking interest rates in December to signalling last week that it could cut rates as early as July.

“We haven’t seen that in Canada, as far as that pivot to the dovish side,” said Michael Greenberg, a portfolio manager at Franklin Templeton Multi-Asset Solutions. “At this point Canada is holding up pretty well.”

Average weekly earnings of nonfarm payroll employees rose by 2.9 per cent in April, the fastest pace since August last year, adding to evidence that Canada’s economy is recovering after a slow down around the turn of the year.

Canadian gross domestic product data for April is due on Friday.

At 3:44 p.m., the Canadian dollar was trading 0.2 per cent higher at 1.3102 to the greenback, or 76.32 U.S. cents. The currency touched its strongest level since Feb. 4 at 1.3092.

The loonie is on track to gain 3.2 per cent in June, while it has gained more than 4 per cent since the start of the year, the best performance among G10 currencies.

Money markets see about a 40 per cent chance of an interest-rate cut this year by the Bank of Canada, while they expect at least two rate cuts from the Federal Reserve.

Still, Canada is a major exporter of commodities, including oil, so its economy could be hurt if progress is not reached on the U.S.-China trade dispute at the G20 summit this weekend.

If the trade war were to drag on and the Fed cuts interest rates, then the Bank of Canada would likely ease more than the market is expecting, Greenberg said.

U.S. crude oil futures held on to strong gains over the past two weeks, settling 0.1 per cent higher at $59.43 a barrel.

Canadian government bond prices were higher across a flatter yield curve, with the 10-year rising 32 cents to yield 1.468 per cent. Earlier in the session, the 10-year yield touched its highest since June 12 at 1.522 per cent.

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