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Yield Gap With U.S. to Expand on Interest-Rate Differential: Canada Credit

The gap between yields on Canadian 10-year bonds and comparable U.S. Treasuries, already at the widest in almost 1 1/2 years, may widen as the difference in interest-rates between the two countries increases.

The yield on Canada’s 10-year benchmark dropped 3 basis points yesterday to 3.23 percent, or 24 basis points higher than that on the 10-year Treasury, 2.99 percent. That’s the biggest gap since Feb. 2, 2009. It could reach 40 basis points by year- end, said Eric Lascelles at Toronto-Dominion Bank.

“The dominant concern is that the Canadian economy is growing, and more importantly, the Bank of Canada is hiking,” Lascelles, the TD Securities unit’s chief economics and rates strategist, said by phone from Toronto. “The long end has been taken along for a ride as the market has priced in rate hikes.”

Traders are raising bets Governor Mark Carney will lift the Bank of Canada’s policy rate by 25 basis points for the second time in two months at a July 20 meeting. The one-month overnight index swap rate, which measures what investors predict the bank’s policy rate will average over that period, closed at 0.7266 percent yesterday, the highest since Feb. 20, 2009.

The central bank’s overnight lending rate target will reach 2 percent by the middle of 2011, according to the weighted average of 15 forecasts in a Bloomberg News survey. That compares with a 0.75 percent forecast for the U.S. policy rate.

Last month, the U.S. Federal Reserve left its key rate near zero and renewed a pledge to keep it low for an “extended period.” Minutes of the June 22-23 session, released July 14, show officials saw no need to boost stimulus, while paring their growth forecasts and noting risks to the recovery had increased.

‘Frustrating Trade’

“It will be a somewhat frustrating trade to get Canada- U.S. spreads to narrow much in the near term,” Mark Chandler, head of Canadian fixed-income and currency strategy at Royal Bank of Canada in Toronto, the nation’s largest lender, said in an e-mail. He sees Canada’s policy rate 150 basis points higher than the Fed’s policy rate in first-quarter of 2011 and predicts the 10-year yield spread will end the year at 25 basis points.

Elsewhere in credit markets, the extra yield investors demand to own the debt of Canadian corporate rather than federal government held steady yesterday at 144 basis points, according to a Bank of America Merrill Lynch index. A basis point is 0.01 percentage point. Overall yields fell to 4.032 percent.

Bank of Nova Scotia plans a benchmark sale of three-year covered bonds in U.S. dollars, according to a person familiar with the transaction. The $2.5 billion of debt is set to yield 25 basis points more than mid-swaps, said the person, who declined to be identified because terms aren’t set.

Leading Indicators

Canada’s index of leading economic indicators advanced for a 13th straight month in June, Statistics Canada is expected to say today, according to the median of 11 forecasts in a Bloomberg survey. The index rose by 0.9 percent in both April and May.

The three-month Canadian dealer offered rate, or CDOR, a proxy for the cost of bank funding over that period, rose yesterday to 0.99 percent, the highest since February 2009.

Canada’s 3.5 percent bond due in June 2020, the 10-year benchmark, rose 27 cents to C$102.26 yesterday in Toronto. The yield will reach 4.1 percent by the middle of next year, the Bloomberg weighted-average forecast of 12 economists shows.

“The market is increasingly betting that rates will be rising and yields will be going up in Canada, and that just means you take a capital loss,” said TD Securities’ Lascelles. “People are a little shy on that.”

To contact the reporters on this story: Chris Fournier in Montreal at cfournier3@bloomberg.net

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