Canada Outlook Shifts, As Currency and Bond Yields Jump

By Daniel KrugerFeaturesDow Jones Newswires

The Canadian dollar is trading near three-month highs, as the country's growing economy, thriving labor market and rising prices for one of its key commodities have boosted the outlook for its currency.

The Canadian dollar slipped 0.4% to $1.2464 Tuesday, after last week hitting its highest level since late September.

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Several factors have contributed to the loonie's rise: Canada added 79,000 jobs in December and finished last year with its strongest annual job gains since 2002, while its unemployment rate declined to 5.7%, the lowest since comparable data became available in 1976, according to Statistics Canada. Inflation has also risen, with consumer prices climbing 2.1% in November from the year earlier.

Another part of the Canadian currency's strength has come from surging oil prices, with U.S. crude settling Tuesday at its highest value since December 2014. Oil has benefited from factors including antigovernment protests in Iran, declining U.S. crude stockpiles, freezing winter weather in the U.S. Northeast and continued high levels of compliance with the Organization of the Petroleum Exporting Countries' plan to cut crude output.

As economic data has shown unexpected strength, investors' outlook for Bank of Canada interest-rate policy has undergone a rapid evolution. That has improved the outlook for the currency, which has risen 3.5% against the U.S. dollar since the end of November. Rising interest rates tend to boost a currency by making it more attractive to yield-seeking investors.

It has also dented the value of Canadian government bonds, with 10-year yields rising 0.18 percentage point faster than the gains in the 10-year U.S. Treasury yield. The 10-year Canadian government bond yield rose Tuesday to 2.19% from 1.89% on Nov. 30.

"Economic data has been spectacular in Canada," said Ugo Lancioni, head of global currency investments at Neuberger Berman Group. This has led investors to reconsider their expectations for the potential for the Bank of Canada to raise interest rates this year, he said.

Investor opinion has coalesced around expectations the rate increases will begin as soon as the BOC's next meeting on Jan. 17, with between three and four increases expected in 2018. That is important because it implies that Canada's central bank could be more vigorous than the Federal Reserve in executing its return to monetary policy norms that prevailed before the 2008 financial crisis. Fed officials have signaled they expect to raise rates three times this year.

Expectations for interest rates are particularly important to supporting the loonie this year, because currencies, like the Mexican peso and the Norwegian krone, of many oil-exporting countries, have failed to match the gains of the commodity itself, Mr. Lancioni said.

Mr. Lancioni said he is buying the Canadian dollar against its counterparts in Australia and New Zealand.

Rising oil prices may not be providing the same amount of support that they usually do for the Canadian currency, but they are aiding it indirectly, while also helping to push bond prices lower, leading to higher yields, said Brendan Murphy, a senior portfolio manager at Standish Mellon.

Strong oil prices lead to a "double whammy" for Canada, as higher prices feed into the consumer-price index, while also boosting exports and industrial jobs, Mr. Murphy said. He said he has placed futures bets on higher bond yields.

Some analysts have highlighted the potential for the currency to lose ground should talks break down in efforts to revise the North American Free Trade Agreement between Canada, Mexico and the U.S.

Still, Republican success in passing tax cuts may have eased some of the pressure for the talks to produce gains for the Trump administration, which means the political risk to the currency may be limited, Mr. Murphy said.

Write to Daniel Kruger at Daniel.Kruger@wsj.com

(END) Dow Jones Newswires

January 09, 2018 18:57 ET (23:57 GMT)