Is the Loonie Really Just a Petro-Currency?

The big news last week was the sudden drop in commodity prices. Many analysts believe this will weaken the loonie and thus increase the likelihood of a Bank of Canada (BoC) rate hike in the summer – largely because the value of our dollar has been highly correlated to the price of oil over the past several years. (Did you know that we are now the seventh largest producer of crude oil in the world, and that we passed Saudi Arabia to became America’s largest supplier in 2000?) Our lofty loonie has played an important role in keeping our recent inflation and growth numbers under control, and if its value falls relative to the Greenback, short-term interest rate hikes by the BoC would be more likely.

But is the loonie really just a petro-currency at this point? Not everyone agrees. There is a lot of negative sentiment around the Greenback, based primarily around the U.S. federal government’s mounting deficits and the federal reserve’s exceptionally loose monetary policy. And the Euro isn’t instilling a lot of confidence these days either. How much of the recent demand for our Loonie is because it is viewed as a relatively safe place for investors to hide, especially when the safety of our short-term government bonds comes with a higher yield? If commodity prices drop further, the answer will become clearer. Either way, it will be interesting to see how this plays out. 

The five-year Government of Canada (GoC) bond yield jumped higher on Tuesday, but it gave back most of that gain over the following days, and finished only marginally higher for the week. Mortgage lenders have continued to inch their fixed-mortgage rates lower but are reluctant to make major moves – probably because of market volatility and the fact that the spread between five-year GoC bond yields and current mortgage rates is keeping profit margins skinnier than normal (a spring market tradition as predictable as new leaves on the trees).

Variable-rate mortgage discounts held firm again this past week. It’s starting to look as though  the lenders who recently cut their discounts will be the exception rather than the new rule.

The bottom line: Keep your eye on the Loonie. If it drops relative to the Greenback, shorter-term rate increases become more likely, but if it stays strong, the BoC may still take the summer off.