Oil Rallied Today. The Canadian Dollar Weakened Anyway.
Brent crude rose 2.5% to $105.69 a barrel this afternoon after Reuters reported that United States and Iranian negotiators in New York are discussing a phased deal to reopen the Strait of Hormuz to commercial shipping, pulling back from an earlier session high near $108 that followed a Houthi missile barrage against Saudi Arabia. West Texas Intermediate rose 2.3% to $94.30. Both benchmarks are up more than 10% for the month.
By the standard playbook, that move should have produced the best possible day for the Canadian dollar. Energy names on the TSX, including Suncor, Canadian Natural Resources and Cenovus, led exchange volume as investors bought into the rally. Instead, USD/CAD rose 0.30% to 1.4143, meaning the loonie weakened on the same afternoon its clearest tailwind strengthened.
The reason sits in the bond market, not the oil market. The Bank of Canada held its policy rate at 2.25% on September 2 with what most desks read as a mildly hawkish tone. The Canada 10-year government bond yield has moved only from about 3.83% on Monday to 3.95% by Wednesday close, a jump of roughly 12 basis points. Over the same window, the U.S. 10-year has surged from the mid-4.90s to 5.12%, its highest level since 2007, on a hot flash composite PMI reading and a weak $70 billion five-year Treasury auction.
Crude, the Canadian dollar and North American equities all moved on the same afternoon headline out of the Hormuz talks, and the size and direction of each move is not what the standard energy-currency playbook would predict.
Energy led every asset class on the session while equities were roughly flat. The Canadian dollar moved opposite to where its usual correlation with oil would place it.
Equities Forgave the Yield Spike This Afternoon. Bonds Never Did.
By early afternoon, North American equities had largely shrugged off the morning yield shock. The Dow Jones Industrial Average was down just 0.26%, the S&P 500 was effectively flat, and the Nasdaq Composite had trimmed its loss to 0.02%, all recovering from a steeper morning selloff that followed the flash September composite PMI reading of 58.4, the fastest pace of United States business activity in more than five years. The same Hormuz de-escalation report that lifted oil also gave equity investors a reason to look past the rate shock.
The Treasury market did not extend the same courtesy. The 10-year yield closed near 5.12% this afternoon, its highest level since 2007, having climbed in nearly every session since late August with no comparable afternoon reversal.
The yield has risen in nearly every session since late August, with the sharpest single-day jump on September 23 following a hot flash PMI reading and a weak five-year Treasury auction. No comparable reversal followed the afternoon Hormuz headlines.
The bond market is pricing the PMI print as durable evidence the Federal Reserve has more tightening ahead, with futures markets now assigning roughly a 70% probability to an October rate increase. The equity market is pricing the Hormuz talks as durable evidence the geopolitical risk premium in oil is starting to unwind. Both readings cannot be the dominant story for very long.
For Canadian advisors, the complication is that Canadian demand data is softening at the same time. Retail sales fell 0.7% in July, weaker than the advance estimate Statistics Canada had published, even as an August rebound is expected. A cooling consumer argues against the Bank of Canada closing the rate gap with the Federal Reserve any time soon, which points straight back to the mechanism in the first section. Tomorrow morning, watch whether the 10-year Treasury yield holds near 5.12% or starts to retreat: that answer, more than the oil headline, will say which market read today correctly.