Carney Rate-Increase Odds Dip Below 50 Percent on Inflation: Canada Credit

For the first time since the Bank of Canada raised interest rates on July 20, bond traders bet that Governor Mark Carney will leave borrowing costs unchanged when he and his fellow policy makers meet in two weeks.

Probabilities derived from overnight index swaps show a 62 percent chance the central bank will keep its main rate at 0.75 percent on Sept. 8, up from less than 40 percent earlier this month, according to Bank of Nova Scotia data. Bank of Montreal calculations put the likelihood of a pause at more than 60 percent from about 45 percent a week ago.

“The September hike was largely accepted as being a sure bet until very recently,” Mohammed Ahmed, a rates strategist at Canadian Imperial Bank of Commerce in Toronto, wrote in an e- mail. “Now the market is much less certain. The current levels are the most dovish we have seen since” rates were increased from 0.5 percent five weeks ago, he said.

Expectations in the bond market for a boost have reversed after reports from Canada and the U.S. showed the economic recovery may be faltering and inflation is slowing. Statistics Canada said Aug. 20 that consumer prices rose 1.8 percent in July from a year earlier, less than 1.9 percent median estimate of 19 economists surveyed by Bloomberg, while the “core” inflation rate decelerated to 1.6 percent.

Photographer: Tomohiro Ohsumi/Bloomberg

Rising speculation that Carney will keep rates steady is giving Canada’s government debt market a boost, driving yields on two-year bonds to the least since February and those on 10-year securities to the lowest in more than a year. Close

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Photographer: Tomohiro Ohsumi/Bloomberg

Rising speculation that Carney will keep rates steady is giving Canada’s government debt market a boost, driving yields on two-year bonds to the least since February and those on 10-year securities to the lowest in more than a year.

Rising speculation that Carney will keep rates steady is giving Canada’s government debt market a boost, driving yields on two-year bonds to the least since February and those on 10- year securities to the lowest in more than a year.

A respite may also help companies by allowing them to arrange cheaper funding. A Bank of America Merrill Lynch index measuring the performance of debt issued by Canadian companies returned 1.71 percent this month, compared with 0.2 percent in July. Government securities yielded 1.29 percent.

‘Not Behind the Curve’

“It increasingly looks like the Bank of Canada is not behind the curve as some had feared” in keeping inflation in check, Camilla Sutton, director of currency strategy in Toronto at Bank of Nova Scotia, wrote in an e-mail.

Elsewhere in credit markets, the extra yield investors demand to own the debt of Canadian corporations rather that of the federal government widened 2 basis points last week to 143 points, Bank of America Merrill Lynch data shows. The spread on the bank’s broad global company-debt index remained at 177 basis points, or 1.77 percentage points.

Yields fell to 3.71 percent on average, down from 3.79 percent a week earlier and the lowest since Feb. 8. The securities have returned 6.43 percent this year, including reinvested interest, lagging behind the 8.36 percent gain for the broader index.

The Week Ahead

The spread on Canada’s provincial bonds held steady at 60 basis points. The securities have returned 1.46 percent this month and 5.99 percent for the year, the Merrill data shows. The country’s government bonds have made investors 1.29 percent in August and 6.06 percent in 2010.

Canada’s 10-year yields fell last week to as little as 2.869 percent, the lowest level since April 2009. The price of the 3.5 percent security due in June 2020 rose 48 cents to C$105.85 in the five days through Aug. 20. The yield is down from 3.768 percent at the start of the year. Canada’s 10-year bonds have averaged about 5.85 percent over the last 20 years, according to Bloomberg data.

Canada will auction C$3.5 billion ($3.3 billion) of real- return bonds on Aug. 25, the Bank of Canada said in a statement last week. The 3 percent bonds mature in December 2015.

A day before the sale, Statistics Canada may say that retail sales rose 0.3 percent in June after dropping 0.2 percent in May, according to the median forecast of 14 economists surveyed by Bloomberg.

TD Sees an Increase

Carney, 45, raised rates by 0.25 percentage point at the central bank’s June 1 meeting and again on July 20, saying further action will be “weighed carefully against domestic and global economic developments.”

Like other banks, Toronto-Dominion Bank said the odds of third successive 0.25 percent increase on Sept. 8 are less likely now. Chances dropped to 55 percent after the inflation report from about 70 percent the day before, the bank said.

“The Bank of Canada is still likely to raise rates in our view, since even at 1 percent the overnight rate would still be very stimulative for the Canadian economy,” Jacqui Douglas, a currency strategist at TD Securities in Toronto, wrote in an e- mail. “The question is how much more tightening we’ll get from the Bank of Canada this year. It seems likely the bank will pause after September to re-evaluate.”

Bax Yields Hit Low

The yield on December 2010 bankers’ acceptances, the most- active contract, fell 9 basis points to 1.11 percent, the lowest level since the contract began trading in December 2007. The yield, which indicates about where traders believe short-term rates will settle when the contract expires, reached 2.5 percent in June.

So-called Bax contracts have settled an average of about 20 basis points above the central bank’s overnight target since 1992, Bloomberg data show. Hedge funds and money managers use the contracts to hedge against interest-rate exposure and make bets. The yield falls as the price rises.

“The soft inflation data is casting some doubts about further rate hikes by the Bank of Canada,” said David Love, who trades the contracts at the brokerage Le Groupe Jitney Inc. in Montreal. “Chances of a September rate hike had recently been taken for granted.”

Love said the move in Baxes after the Aug. 20 inflation report was being “exacerbated by short-covering,” in which traders buy a contract to cover previous bets that it would fall.

“I think we are close to the high and quite overdone,” Love said, referring to the price of the contracts.

The likelihood assigned to a rate increase in October slumped to 20 percent on Aug. 20 from 35 percent the day before, CIBC data showed. Chances of a December rise remained at 10 percent.

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

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