Yield Forecasts Tumble as Carney Prepares for Rate Meeting: Canada Credit

Economists are slashing forecasts for Canada’s government bond yields amid signals of a faltering economic recovery before the Bank of Canada meets next week to determine interest-rate policy.

Canada’s benchmark two-year bonds will yield 1.55 percent by Dec. 31, according to the weighted average of 7 estimates compiled by Bloomberg News. That’s down from a July forecast of 2 percent, the survey showed. The forecast for the 10-year bond fell to 3.1 percent, from 3.35 percent a month earlier, according to survey results released Aug. 30.

Investors piled out of stocks and into perceived safety of government debt last month after Statistics Canada released weaker-than-forecast economic data. An Aug. 31 report showed the 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. Market data indicate a slightly better-than-even chance Bank of Canada Governor Mark Carney will increase the official short-term interest rate to 1 percent on Sept. 8.

“Forecasters are having to allow for the continued flow of money out of risk assets and into safe-haven assets, such as government bonds,” Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said by phone from Toronto. CIBC reduced its year-end, 10-year yield forecast to 3.1 percent last month, from a June forecast of 3.75 percent.

Yield Trends

Two-year yields reached an 18-month high 2.07 percent in April, before the European debt crisis kicked off concern the global economic recovery was floundering, sending investors scrambling for safety. The yield slumped to as low as 1.16 percent on Aug. 24. It ended yesterday at 1.28 percent.

Global stocks fell in August, with the MSCI World Index down 3.9 percent, the most in four months and Canada’s dollar declined 3.4 percent, the biggest loss versus the greenback since June 2009. The national statistics agency last month reported 2010’s first jobs losses, and inflation and retail reports that failed to meet economists’ expectations.

Elsewhere in credit markets, the extra yield investors demand to own Canadian corporate bonds rather than federal debt widened to 149 basis points yesterday, from 145 basis points last week, according to a Bank of America Merrill Lynch index. Spreads have been as wide as 154 basis points and as narrow as 114 basis points this year. Yields rose to 3.72 percent yesterday, from 3.63 percent on Aug. 30.

Provincial Sales

British Columbia sold C$500 million of 4.3 percent bonds due in June 2042. The debt was priced to yield 83 basis points over benchmarks. Canada’s western-most province paid 81 basis points over benchmarks in January when it issued C$500 million of 4.95 percent bonds due in June 2040.

Spreads on provincial bonds narrowed to 59 basis points yesterday, from 60 basis points the day before, according to a separate Merrill Lynch index. The yield on the bonds, which have returned 6.4 percent this year, ended yesterday at 3.01 percent.

Citigroup Inc. will hold a Sept. 8 meeting with potential investors to discuss financing for the acquisition of Tomkins Plc by Canada Pension Plan Investment Board and Onex Corp. for 2.89 billion pounds ($4.5 billion), according to a person familiar with the transaction. They will fund the acquisition with $3 billion of underwritten debt.

Government bonds fell yesterday, sending the yield on the benchmark 10-year up 1 basis point, or 0.01 percentage point, to 2.86 percent. It touched 2.745 percent on Aug. 31, the lowest since March 2009. The price of the 3.5 percent security maturing in June 2020 fell 9 cents to C$1.0539.

The two-year’s yield dropped yesterday to 1.28 percent.

Policy Meeting

Bank of Canada policy makers meet Sept. 8 in Ottawa to decide whether to raise interest rates for the third time since June 1. Economists trimmed year-end forecasts for the central bank’s policy rate, now at 0.75 percent, to 1 percent last month, from 1.5 percent in July, according to the weighted average of 11 estimates in a separate Bloomberg survey.

Chances the bank will raise the policy rate to 1 percent stood at about 55 percent yesterday, according to Royal Bank of Canada’s RBC Capital Markets unit. The yield on December 2010 bankers’ acceptances, the most-active contract, closed yesterday 1.12 percent, up from an intraday low of 1.03 percent on Aug. 24, the least since the contract started trading in December 2007. The yield is a barometer of short-term rate expectations.

Government bonds have returned 2.2 percent since July 20, the day the Bank of Canada raised its policy rate to 0.75 percent. Two-year yields stood at 54 basis points over the bank’s policy rate yesterday, compared with 102 basis points on July 19, the day before the central bank’s last increase.

Rate Forecasts

CIBC’s Shenfeld said the level of cash in the government bond market may signal it’s time to get back into stocks.

“Even though growth may be somewhat disappointing, investors have overdone it,” he said. “It’s time to dip the toe back into the equity market or perhaps even corporate bonds that give you a bit of spread.”

Among the year-end 2-year forecasts, Ryan Brecht at Action Economics LLC in Hillsborough, California is highest at 2.05 percent. Francois Dupuis at Desjardins Securities Inc. in Montreal and Douglas Porter at Bank of Montreal in Toronto are lowest at 1.4 percent.

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

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