Canada’s loonie (CAD) traded at .6939 U.S. this morning, the lowest since January 2003.
Part of the weakness comes from the Canadian overnight rate at 3.25%, which is expected to be cut to 3% on January 29, 133 basis points (bps) below the current U.S. effective funds rate at 4.33%.
Foreign capital flows where it’s treated best. The 2-year Canadian Treasury yield, at 2.932%, trades a wide 135 basis points below the U.S. 2-year yield, at 4.282%—making for the relatively least attractive nominal Canadian yield spreads in over a decade (2-year Canada vs. U.S. yield spread charted below since April 2015).
That said, inflation rates have fallen faster in Canada (1.8% yoy in December vs. 3% in America), so on an after-inflation basis, Canadian 2-year real yields are a tighter 1.13% compared with 1.28% in the U.S.
The prospect of increased trade tariffs between the two major trading partners is a wild card for inflation and rates. Canada’s economy comes into the negotiations weaker and more vulnerable than America.
Historically, the commodity-centric Canadian dollar bottoms against the greenback near the end of recessionary bear markets after the U.S. Fed and Bank of Canada have been working to ease credit for several quarters. So far, this time, central banks have had less influence in lowering market interest rates than in past cycles.
The loonie bottomed in the spring of 2009, as the stock market completed a -50%, 3-year drubbing, and oil prices hovered near $30 a barrel. It also bottomed in the summer of 2002, as the stock market halved over two years and oil prices hovered around $25 a barrel.
Remarkably, the loonie is weaker today than the risk-off pandemic lows of March 2020, when the stock market plunged 37% in three weeks and oil prices went negative. Yet, so far, the stock market remains near all-time highs, and West Texas Crude is around $75.
Retesting the January 2002 all-time USD/CAD high of $1.60 is possible if unfavourable financial/economic developments cause the Bank of Canada to ease more aggressively than currently priced in. That would also suggest downside for still-high equity prices and more upside for Canadian Treasury prices.
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