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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.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/05/24 4:00pm EDT.

SymbolName% changeLast
RY-T
Royal Bank of Canada
-0.58%143.31

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