Bond Rally Sets Stage for Bigger Losses, Economists Predict: Canada Credit

The rally in Canada’s 10-year benchmark bond since the beginning of May hasn’t convinced economists to alter their forecast that its yield will rise to 4 percent by the end of the first quarter of 2011, implying greater losses than previously forecast.

The bond’s yield, which fell to 3.234 percent yesterday -- the lowest since Nov. 30 -- will keep rising to 4.1 percent in the second quarter of next year, according to the median of seven estimates garnered in a Bloomberg survey of analysts. A 4 percent yield on March 31, 2011, implies a 6 percent drop in price for a bondholder, according to a Bloomberg calculation.

“We’ve reduced the outlook for bond yields through most of 2010, but we think it’s basically just delaying the inevitable,” said Doug Porter, deputy chief economist at BMO Capital Markets in Toronto. “The underlying trend in rates in 2011 will be higher.”

Bank of Canada Governor Mark Carney, who raised his policy interest rate on June 1 to 0.5 percent from a record-low 0.25 percent, said on June 16 future moves to increase interest rates aren’t “preordained” because of an uneven global recovery. Canada’s 10-year note yield has fallen by 19 basis points since June 15 and 42 basis points since April 30. The 3.5 percent security due June 2020 rose 26 cents yesterday to C$102.26.

‘Flight to Safety’

“Clearly, 10-year yields have been dragged down in part by the sharp drop in U.S. 10-years on a flight-to-safety bid from equities,” said Avery Shenfeld, chief economist at CIBC World Markets in Toronto. “If equity markets can find their footing and start creeping higher again, we expect 10-year yields to start to move higher.”

Shenfeld cut his forecast for the yield in the third quarter to 3.5 percent from 3.8 percent last month, while leaving unchanged his prediction of a 4 percent yield in the first quarter of 2011. Shenfeld said that while he hasn’t changed his views on how the economy will evolve, “in the near term, our previous target looked a bit high.”

Elsewhere in credit markets, Ontario increased the amount of its 3 percent bond maturing May 2013 in Norwegian currency by 250 million kroner ($38.6 million). Four provinces sold treasuries due in September: Newfoundland and Labrador sold C$38 million ($36.6 million), Manitoba sold C$100 million, Quebec sold C$175 million and Ontario sold C$700 million.

The extra yield investors demand to own the debt of Canadian corporate rather than federal government debt held steady yesterday at 150 basis points, or 1.50 percentage points, according to a Bank of America Merrill Lynch index. The yield was as narrow as 114 basis points on March 19.

Canada Benefits

“It’s really just a risk-averse move to take money out of equity markets, but particularly to take it out of Europe and put in the U.S.,” said Robert Carnell, chief international economist at ING Financial Markets in London. “Canada just benefits from the U.S. move.”

ING cut its forecast for the 10-year yield to 4 percent at the start of 2011, from the 4.4 percent it predicted last month. Carnell said the European fiscal situation will drive yields next year, rather than domestic factors.

BMO’s Porter shaved his yield forecast by 30 basis points for the third quarter to 3.38 percent, citing lower global growth and commodity prices, a slower pace of tightening in monetary policy and heightened market uncertainty. He boosted his expectations for the first three quarters of 2011 by 5 points, and said the recent drop in yields is “clearly” a result of a flight to safety.

“The 10-year yield is a mix of a lot of different things: it’s partly driven by the long-term view on growth and inflation,” Porter said. “But it of course also reflects current market dynamics -- it can be affected quite abruptly by investor sentiment in the here and now, and I think that’s what we’ve seen in recent months.”

To contact the reporter on this story: Alexandre Deslongchamps in Ottawa at adeslongcham@bloomberg.net.

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.