The Canadian dollar weakened against the greenback on Monday, as the yield on the benchmark government bond climbed to its highest level in more than a year. The loonie was trading 0.2% lower at C$1.3553 to the greenback, or 73.78 U.S. cents, after trading in a range of 1.3536 to 1.3583. The Canadian dollar was under pressure from the rising bond yields, which reflected the expectations of higher inflation and interest rates.
Bond Yields Surge on Inflation Fears
The yield on the Canadian government 10-year bond rose 5 basis points to 2.89%, its highest level since February 2020. The yield, which moves inversely to the price, was driven by the rising inflation fears, as the global economy recovers from the pandemic and the commodity prices surge. The yield was also influenced by the U.S. Treasury yields, which also spiked on Monday, reaching 3.15%, the highest since March 2020.
The rising bond yields signal the market’s anticipation of higher inflation and interest rates, which could erode the value of the fixed-income assets and the purchasing power of the currency. The bond yields also affect the borrowing costs for the government, businesses, and consumers, which could impact the economic growth and activity.
Loonie Loses Ground on Rate Differentials
The Canadian dollar lost ground against the U.S. dollar, as the rate differentials between the two countries widened. The Bank of Canada (BoC) has kept its key interest rate at 0.25%, the lowest level on record, and has pledged to maintain it until the economic slack is absorbed and the inflation target is sustainably achieved. The BoC has also maintained its quantitative easing program, buying at least C$4 billion worth of government bonds per week, to support the economic recovery and the financial stability.
The U.S. Federal Reserve (Fed) has also kept its key interest rate near zero, and has continued its asset purchase program, buying $120 billion worth of Treasury and mortgage-backed securities per month. However, the Fed has signaled that it could start tapering its bond buying later this year, and could raise its interest rate sooner than expected, depending on the economic data and the inflation outlook. The Fed has also revised its inflation forecast for 2023, projecting a 2.4% increase, above its 2% target.
The diverging monetary policies between the BoC and the Fed have created a gap between the Canadian and the U.S. interest rates, which makes the U.S. dollar more attractive and the Canadian dollar less competitive. The interest rate differential also affects the currency exchange rate, as the investors seek higher returns and lower risks.
Loonie Outlook Depends on Multiple Factors
The Canadian dollar outlook depends on multiple factors, such as the global economic recovery, the commodity prices, the domestic economic data, and the COVID-19 situation. The loonie could benefit from the strong global demand for oil and other commodities, which are major exports for Canada. The loonie could also gain from the robust domestic economic performance, which could prompt the BoC to tighten its monetary policy sooner than expected. The loonie could also rally from the improvement of the COVID-19 situation, which could ease the lockdown measures and boost the consumer confidence and spending.
However, the loonie could face headwinds from the rising bond yields, which could weigh on the currency and the economy. The loonie could also suffer from the uncertainty and volatility of the global markets, which could trigger a flight to safety and a preference for the U.S. dollar. The loonie could also weaken from the worsening of the COVID-19 situation, which could hamper the economic recovery and the vaccine rollout.
The Canadian dollar fell as the benchmark yield rose. The loonie was pressured by the rising bond yields, which reflected the inflation and interest rate expectations. The loonie also lost ground against the U.S. dollar, as the rate differentials between the two countries widened. The loonie outlook depends on multiple factors, such as the global economic recovery, the commodity prices, the domestic economic data, and the COVID-19 situation.