[DanRath]

That front end yields in Australia should have risen relative to Canada therefore seems sensible, but might the front end loading of rate hike expectations in Australia relative to Canada have gone too far? Developing external risks in both cases suggest this might be the case. Positive developments in China are playing no small part in the Australian recovery story. The relationship between the rebound in commodity prices, especially base metal prices, and China’s economic turnaround is well known. Also, with 15% of Australian exports directly heading to China and an additional 53% to the rest of Asia, which are also directly and indirectly tied to the fortunes of the Chinese economy, the RBA could quickly step away from its expected normalization process if the Chinese recovery falters as the PBoC reigns in excessive monetary stimulus.

Although Canada will also be adversely affected in such a scenario through its commodity-linkages, the impact will be less severe with Canadian exports much less dependent on Asia. Moreover, one of the principal downside risks to Canadian growth – exposure to the US – is at the very least diminishing as the evidence of stabilisation in US output continues to mount, not least this week’s sharp rise in the manufacturing PMI. The BoC will be cautious in taking this news flow on board. But with the interest rate markets fully priced for the BoC’s low rate commitment holding, the risk to rate expectations is asymmetric to the upside. With AUD/CAD having twice failed at the top of the recent range just above 0.90, the risk is for a near term pull-back to the bottom of the range at 0.8800.