Canada's stock market got a lift from higher oil prices on Tuesday, but the Canadian dollar barely budged. The loonie remained pinned near the lows it hit during the April 2025 tariff turmoil, underscoring a shift in what's driving the currency.
The S&P/TSX Composite Index finished up 0.33%, helped by gains in cyclical sectors and energy stocks. The catalyst: US benchmark West Texas Intermediate (WTI) crude settled 2.3% higher at $71.92 a barrel, bouncing after recent weakness. Part of that move reflected renewed worries about Middle East shipping after reports of an incident near the Strait of Hormuz, a key chokepoint for global crude supplies.
Why the Loonie Isn't Following Oil Higher
Normally, a rise in oil prices is good news for the Canadian dollar. Canada is a major energy exporter, and higher crude prices mean more US dollars flowing into the country to buy its oil. That increased demand for Canadian dollars to settle those transactions typically pushes the loonie higher.
But this time, the currency barely responded. According to Corpay, a payments firm with a currency research unit, the bigger force at play is a widening gap between short-term US and Canadian government bond yields. Since early May, the spread between two-year US Treasury yields and two-year Canadian government bond yields has been growing.
That yield gap matters because it creates a "carry" advantage for holding US dollars. In plain English: investors can earn a higher interest rate on US cash than on Canadian cash. That difference gets baked into hedging costs and forward exchange rates, making the US dollar more attractive relative to the loonie.
Corpay's Karl Schamotta noted that this two-year yield spread has widened since early May, even as USD/CAD climbed above 1.42 — more than 0.06 higher than late April. That means it now takes more than 1.42 Canadian dollars to buy one US dollar, a level not seen since the tariff-related selloff in April 2025.
Soft Jobs Data and a Patient Bank of Canada
Adding to the loonie's woes: softer-than-expected labor market signals from Statistics Canada. Recent jobs data showed the Canadian economy added fewer positions than forecast, and the unemployment rate ticked up. That gives the Bank of Canada little reason to raise interest rates anytime soon.
Markets now expect the Bank of Canada to keep its policy rate steady at its next meeting, while the US Federal Reserve remains in a tightening bias. That divergence in monetary policy outlook further widens the yield gap and reduces the incentive for investors to park money in Canadian-dollar assets — even when oil has a good day.
What It Means for Investors
For Canadian investors, the message is mixed. The TSX can rise in local terms, but foreign investors measuring returns in US dollars may see those gains shrink if the loonie doesn't follow oil higher. That's a headwind for Canadian stocks that are popular with international buyers.
For US investors looking north, the weak loonie makes Canadian stocks cheaper in dollar terms, but the currency risk means any future loonie recovery could eat into returns. The key level to watch remains USD/CAD above 1.42. If the yield gap continues to widen, the loonie could stay under pressure even if oil rallies further.
The broader backdrop is one where interest rate differentials are trumping commodity prices as the main driver of currency moves. That's a shift from the pattern that held for much of the past decade, when oil was the dominant force for the loonie. Investors should keep an eye on both the Bank of Canada's next policy decision and the US jobs data due later this week for clues on where the yield gap — and the loonie — are headed next.
For more on how currency moves are playing out in other markets, see our coverage of the South African rand's recent strength and the rally in Latin American stocks and currencies as the US dollar weakened. And for a look at how the Canadian dollar has behaved in similar situations, check out our earlier report on the loonie's bounce after a seven-day slide.
