Bond Bears to Lose Bravado With Canada Yields at 7-Year High

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(Bloomberg) -- Bears feasting in Canada’s government bond market may be getting a little too greedy.

Yields on two-year and five-year government debt have reached the highest since 2011, surging 120 basis points since June. That mirrors a rise in 10-year U.S. Treasury yields which pushed past the 3 percent barrier for the first time since 2014 this week.

But Canada is no U.S., where economic growth is forecast to be stronger this year amid corporate tax cuts and increased fiscal spending. Growth in Canada is poised to slow markedly from 2017 and that may push investors to reassess their views for interest-rate increases in the world’s 10th biggest economy, according to Sun Life Investment Management and Toronto-Dominion Bank.

“As expectations for growth set around 2 percent, you could certainly have scope for yields to move lower” later this year, said Randall Malcolm, managing director for total return fixed income at Sun Life Investment Management in Toronto, which has C$37 billion ($29 billion) in money market and fixed income assets.

Bank of Canada Governor Stephen Poloz held the central bank’s benchmark interest rate steady at 1.25 percent last week after three previous hikes and gave few signs he’s in a hurry to raise them further. Inflation may have risen above the middle of the central bank’s target but he sees that as temporary and made clear the target is a range.

Target Range

“What I don’t want is for people to be spending this entire year asking me what I’m up to because inflation is above target,” Poloz told reporters in Washington Saturday. “You need once in a while to remind people that there’s a range and that’s okay, the policy allows for this. We’re not violating our target in some way.”

The pace of further hikes “will be determined by the data, how the economy is performing,” Poloz told lawmakers in Ottawa on Wednesday.

The latest inflation reading came in at 2.3 percent, above the 2 percent midpoint, yet still well below the top of the target at 3 percent. The economy is seen slowing to 2.1 percent this year, from 3 percent, according to forecasts compiled by Bloomberg, as both housing and industrial output are expected to take a breather.

The bond market doesn’t seem convinced. Canadian federal government debt lost 2.4 percent in the past year and is down 0.9 percent year-to-date, on track for its worst year since 2013, according to a Bloomberg Barclays index.

Canada’s two-year yield fell two basis points to 1.91 percent on Thursday, declining from a seven-year high a closing basis. The rate on five-rate bonds fell three basis points to 2.16 percent, also slipping from the highest since 2011.

Spreads Widening

Both two-and five-year yields have gone too high with the market expecting the Bank of Canada to move too swiftly with hikes, according to Toronto-Dominion Bank’s senior rate strategist Andrew Kelvin. The market consensus is for two more rates increases, most likely in July and either in October or December, according to overnight swaps data compiled by Bloomberg. TD expects one hike from the central bank this year, in July at the soonest.

“Insofar as the Bank of Canada can tighten much more slowly than the Fed can, there is scope for front-end rates in Canada to diverge from U.S. Treasuries,” Kelvin said. He sees the spread between U.S. and Canadian two-year yields widening further to 65 basis points from 57 basis points, the highest since June, as yields north of the border retreat and U.S. yields reach a ceiling.

Candice Bangsund, a portfolio manager at Fiera Capital, is wary about jumping into Canadian government debt yet. The Montreal-based fund manager, recommends staying underweight fixed income but would look for opportunities in the corporate sector.

“Rates are going higher across the entire curve, more so at the long end,” Bangsund said in an interview on BNN TV on Wednesday. A “stronger global economy and higher crude prices should lend support to the riskier sectors of the market versus the government bonds.”

Anything more than two interest rate hikes from the Bank of Canada would be a surprise, Sun Life’s Malcolm said.

“You could see yields go further higher right now, but it would be transitory,” he said. “Once we’ve reached that tipping point, you’re going to get the front end of the curve moving down again.”

©2018 Bloomberg L.P.

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