A recently rising Canadian dollar and higher bond yields are weighing against the Bank of Canada’s efforts to deliver as much monetary stimulus as possible, but they also signal economic optimism, says CIBC World Markets.

A research note published today by CIBC chief economist, Avery Shenfeld, observes that recent activity in the bond and currency markets appears to be leaning against the Bank of Canada’s efforts to stimulate the economy with rock-bottom interest rates. For one, government bond yields are rising, in anticipation of future inflation and rate hikes, and a return to riskier assets. At the same time, the loonie is strengthening, up 7% against the U.S. dollar in the past month.

“So it would seem that Bay Street has taken up arms against Governor Carney’s efforts to provide maximum monetary stimulus to the Canadian economy,” he says. However, the report adds that while Carney may prefer a softer dollar and a flatter yield curve, “he might not at this point be too alarmed by what has transpired.”

“Both the Canadian dollar buying and government bond selling reflect greater optimism than the worst case scenarios for the global economy will be avoided, and that a recovery will begin at some point this year,” he says, adding that this isn’t far from the central bank’s own expectations. “And in turn, the markets sunnier disposition has benefits for the Canadian economy that could counter at least some of the drag from the shifts in currency and government debt markets,” he adds.

Notably, it could prevent some of the feared corporate collateral damage from the financial crisis. “Carney has often cited the risks to the global financial system as a major downside worry. The better tone to the world’s equity markets may be just enough to allow the weakest players to raise sufficient equity capital to stay in the game,” Shenfeld suggests.

While the uncooperative bond market may signal a silver lining, the higher dollar is more clearly leaning against the Bank’s intentions. “Other than threatening to intervene or print loonies with abandon, there’s nothing much Carney can do on that score,” he notes. “But we’re betting that the [Canadian dollar] rally will let up on its own, given the drag from the trade balance and a likely stall in oil prices in the weeks ahead.”

IE