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It's probably an overstatement to say that global bond yields encompass the sum of all human economic knowledge, but it's still pretty close. With that in mind, Canadians concerned about the future course of the loonie should closely follow the course of U.S. and Canadian two year interest rates – particularly if the U.S. Federal Reserve raises short term rates in June as expected.

The chart below shows the value of the Canadian dollar in U.S. dollar terms, compared with the differential in U.S. Treasury and Government of Canada bond two year interest rates. The last data points on the chart, for example, show that the Canadian dollar was trading at $0.80, and that on March 2, the difference between two year Treasury yields (which were at 0.65 per cent) and Canadian two years (0.49 per cent) was -16 basis points.

SOURCE: Scott Barlow/Bloomberg

The first thing evident on the chart is that the two lines are closely related. When the lines diverge, it's always temporary. The relationship is backed up by correlation analysis – the r-squared is a highly statistically significant 0.79. (Yes, yes, this does not mean one factor causes the other. The chicken-and-egg-which-came-first question, and the possibility that other factors are involved, remains).

The subjective explanation for the close connection between currency and bond yields is based on investment flows. North American and global bond investors will, all else being equal, attempt to maximize returns by buying bonds with the highest yields. So, when Canadian bonds yields are higher than U.S. yields, more investors will buy them. This buying will push the value of the loonie higher as foreign investors exchange their currencies for Canadian dollars to make the purchase.

The process is constantly self-correcting. Avid foreign interest in domestic bonds, for instance, causes higher bond prices and declining yields (price and yield moves in opposite direction, as always.) Eventually, the yield differential closes.

The spread between U.S. and Canadian rates, and its effect on the loonie, will be exceedingly important in 2015 if the Federal Reserve raises interest rates. Higher U.S. interest rates and bond yields will attract more foreign investment, partly at Canada's expense. Unless Canadian rates rise along with Treasuries (they always do to some degree), the domestic currency is likely to weaken further. But, if Government of Canada bond yields rise, this will reduce borrowing and limit overall domestic economic growth, not to mention housing prices.

Follow Scott Barlow on Twitter @SBarlow_ROB.