The Canadian dollar ended the third quarter within 0.3% of where it began even though WTI crude gained 28.6% over the same 62 sessions, which means the currency is trading the gap between US and Canadian two-year yields and not the oil price. USD/CAD stood at 1.4210 on June 30 and 1.4188 on September 29, the last Bank of Canada observation of the quarter.
Oil Carried the Hormuz Uncertainty and the Currency Carried Something Else
WTI indexed to 100 on June 30 reached 152 on September 15 and finished at 129, while USD/CAD indexed the same way stayed between 97 and 100. Daily changes in USD/CAD correlated at 0.63 with daily changes in the US-Canada two-year yield gap and at -0.22 with daily WTI returns across those sessions (HDQ calculation).
WTI is the front-month futures close and USD/CAD is the Bank of Canada daily rate, each indexed to 100 on June 30. The Bank of Canada publishes no rate for September 30, so both series end on September 29.
This morning the Geopolitical desk showed Hormuz flow estimates differing by a factor of four, and WTI traded between $89.38 and $105.83 in September. The currency did not follow that range. Today supplied a same-day reading: WTI rose about 3% to near $93, the US dollar index gained 0.6% to 102.04, and USD/CAD finished 0.1% lower, at 1.4222 (Yahoo Finance). Oil helped at the margin, as the negative correlation implies, but the currency move was small next to the oil move.
Two Bond Markets Price the Same Distance From Policy
The US-Canada two-year yield gap widened from 133 to 152 basis points between August 31 and September 29, and USD/CAD rose 2.3% over the same stretch, from 1.3866 to 1.4188.
The gap is the US Treasury two-year par yield minus the Government of Canada two-year benchmark yield, in basis points, shown on the right axis. The Federal Reserve raised its target range to 3.75% to 4.00% on September 16; the dashed line marks the June 30 USD/CAD level of 1.4210.
The move came from both sides. The US two-year rose 55 basis points to 4.89% (US Treasury) after the Federal Reserve raised its target range to 3.75% to 4.00% on September 16, while the Canadian two-year rose 36 basis points to 3.37% (Bank of Canada) with the overnight rate unchanged at 2.25%. That puts the Canadian two-year 112 basis points above its policy rate, against roughly 101 for the US two-year above the midpoint of the Fed range. A central bank that has not moved has a bond market pricing almost the same distance from policy as one that has.
The Economy desk established this morning that the Bank of Canada can look through energy-driven inflation on October 28. The 90-day bill at 2.39% and hike odds of 40.8% (rateprobability.com, October 1) price that meeting. The two-year prices what comes after it. On the Fed side, October hike odds fell from 70.9% on Monday (CME FedWatch via Benzinga) to about 30% today (Investing.com Fed Rate Monitor), while the US two-year moved only from 4.92% to 4.88% (Treasury). Near-dated odds can swing 40 points without shifting the part of the curve that tracks the currency.
The Currency Leg Changes Sign Depending on the Window
The Behavioural desk showed this morning that the TSX is down 2.85% for September and up 1.09% for the quarter. The currency leg has the same shape. USD/CAD fell 2.5% across July and August and rose 2.8% in September, measured on Yahoo Finance daily closes through September 30. The S&P 500 in Canadian dollars (price return) returned -0.1% in July and August against +4.1% for the TSX, +2.3% in September against -2.85%, and +2.2% for the quarter against +1.1%.
The September gap of 5.2 points splits into 2.4 points of equity, a 0.45% loss for the S&P 500 in US dollars against 2.85% for the TSX, and 2.8 points of currency. A Canadian portfolio holding US stocks without a currency hedge therefore carried a position on the yield gap, and both central banks decide on October 28. Oil exposure did not hedge it, since oil rose 29% in the quarter and the currency finished it where it started. The 2.8 points the gap added in September are the points it would return if the two October 28 decisions narrow it.