Carney Rate Outlook Fades in Biggest Bond Rally Since 2008: Canada Credit

Canadian investors are paring bets that central bank Governor Mark Carney will increase lending rates after growth in the second quarter slowed to almost one- third the pace of the January-March period and capped a month of weaker-than-forecast reports.

The yield on December 2010 bankers’ acceptances, the most- active contract, yesterday fell 2 basis points to 1.1 percent, down from 1.6 percent in June, indicating investors see a lower probability that Carney will raise the bank’s overnight lending rate to 1 percent, from the current 0.75 percent, at the Sept. 8 announcement. The bankers’ acceptances declines come as a survey found two-thirds of economists are still forecasting a rate increase. Government bonds returned 2.2 percent last month, the most since December 2008.

The Canadian economy grew at an annualized 2 percent in the second quarter, down from a 5.8 percent rate in the first quarter and lower than any estimate in a Bloomberg survey of 18 economists, Statistics Canada said yesterday. The agency last month reported the first jobs losses in 2010, and inflation and retail reports that failed to meet economists’ expectations.

“A string of disappointing Canadian data and a darkening global outlook have weighed heavily on the market’s conviction for a September hike,” said David Tulk, a senior macro strategist at Toronto Dominion Bank in Toronto.

Canadian government bonds returned 2.24 percent in August, the most since December 2008, according to Bank of America Merrill Lynch data.

Spread Narrows

The difference between the Bank of Canada’s rate of 0.75 percent and the yield on the two-year bonds shrank to 0.46 percentage point yesterday, according to Bloomberg data. That’s down from this year’s high of 1.8 percentage points in April, just before policy makers started to raise rates from 0.25 percent. A shrinking gap typically signals that investors doubt borrowing costs will rise much more.

“While it’s not a slam-dunk, because the Canadian economy is still performing OK, without the smoking gun and no real pressure points in the economy,” Carney can be patient, said James Dutkiewicz, a portfolio manager at CI Investments Inc. in Toronto, which manages about C$10 billion ($9.4 billion).

Elsewhere in credit markets, Ontario and Saskatchewan sold debt and the extra yield investors demand to own Canadian corporate bonds rather than federal debt widened.

Ontario sold C$600 million of 4.6 percent June 2039 bonds, bringing the total outstanding for that security to C$9.7 billion. The bonds were priced to yield 93 basis points more than federal government debt.

Provincial Bonds

Saskatchewan sold C$200 million of 4.75 percent June 2040 bonds, boosting the total outstanding to C$1.05 billion. The security was priced to yield 82 basis points more than its Canadian counterpart.

The corporate yield gap widened to 149 basis points, from 145 points the day before, Bank of America Merrill Lynch data showed. During the month, the spread has been as wide as 152 points and as narrow as 141 points.

Corporate bonds returned 2.3 percent in August, bringing the year-to-date return to 7 percent, compared with a monthly return of 2.2 percent and a year-to-date return of 7.1 percent for government bonds. Provincial and municipal bonds performed better, with returns of 2.5 percent in August and 7.1 percent so far this year.

The December future’s yield fell last week to 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 1.6 percent in June.

Bax Settles

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 yield on Canada’s 2-year benchmark bond fell the most since Aug. 24 to 1.2 percent. The price of the 2 percent security due in September 2012 climbed 10 cents to C$101.57.

While investors are betting Carney will be swayed by the weaker reports and the slower-than-forecast U.S. recovery, some economists forecast that the bank will judge that there is too much stimulus in the economy. Carney was the first among Group of Seven central bankers to raise borrowing. After the September meeting, the bank will have announcements on Oct. 19 and Dec. 7.

Economists “have generally held on to their belief that there is enough evidence for the Bank to raise its overnight rate,” Tulk said.

Eight of 12 economists surveyed by Bloomberg predict the bank will increase lending rates next week, compared with four who expect the bank to stand pat. Two economists, Avery Shenfeld at Canadian Imperial Bank of Commerce in Toronto and Stefane Marion at National Bank Financial in Montreal, changed their forecast after the GDP report to say Carney won’t move.

“Given the relatively good domestic demand and the absence of hints from the Bank, it’s reasonable to expect it will raise rates in September,” said Benoit Durocher, an economist with Mouvement Desjardins, Quebec’s largest credit union, in Montreal. “In October, on the other hand, we’ll get the Bank’s updated forecast and I think at that point the Bank of Canada will integrate the U.S. economy’s difficulties to its forecast.”

To contact the reporters on this story: Alexandre Deslongchamps in Ottawa at adeslongcham@bloomberg.net; Ilan Kolet in Ottawa at ikolet@bloomberg.net.

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