Yield Advantage Over Treasuries Dwindles on QE Speculation: Canada Credit

Canada is losing its yield advantage over the U.S. on speculation government bond markets may have gone too far in anticipating the scale of stimulus from the Federal Reserve next week.

Canadian 10-year bonds yielded 18 basis points more than their U.S. counterparts yesterday, near the narrowest gap in almost three months and down from as much as 37 basis points on Oct. 7. Longer-term bond prices are falling faster in the U.S. than in Canada, pushing yields up more quickly.

That difference may narrow further as prices for Canadian bonds rise on speculation a scaled-down program of so-called quantitative easing won’t be as inflationary as a larger program. The U.S. central bank may limit bond purchases to a few hundred billion dollars at next week’s meeting, the Wall Street Journal reported yesterday, without saying where it got the information. In general, bond prices fall in times of higher inflation.

“QE-Light is what many are expecting now,” John Clinkard, chief economist for Canada at Deutsche Bank AG’s Deutsche Bank Securities, said by phone from Toronto. “The Fed is viewed as not being quite as aggressive regarding QE as a lot of people were expecting. If they eased off, I think this would have a somewhat positive impact on Canada.”

The gap in 10-year yields reached an 18-month high in Canada’s favor on Oct. 7. Since then, 10-year Treasury yields have climbed 34 basis points, compared with 15 basis points on the Canadian side. The gap in 30-year yields was 55 basis points in favor of the U.S. yesterday, the most since May.

Goldman Sachs

Elsewhere in credit markets, Goldman Sachs Group Inc. sold C$500 million ($487 million) in so-called Maple Bonds, debt sold by foreign companies in Canadian dollars. The 4.1 percent notes mature in November 2015, and were priced at 206.4 basis points over the Canadian government 3 percent bond due December 2015.

The extra yield investors demand to hold the debt of Canada’s corporations instead of its federal government was unchanged at 142 basis points, or 1.42 percentage points, down from 145 at the end of September, according to Bank of America Merrill Lynch data. The so-called spread in U.S. corporate bonds tightened 8 basis points this month to 178. Global corporate bonds narrowed 8 basis points to 165 as of Oct. 26.

Canadian corporate yields ended yesterday at 3.67 percent, from 3.63 the day before and 3.66 at the end of September, according to the Merrill index, which holds more than 700 bonds with a par value of C$278 billion. The index has declined 0.1 percent this month, after five months of gains.

Gateway Casinos

U.S. corporate bonds have lost 0.4 percent in October, while global corporate had fallen 0.1 percent as of Oct. 26, the Merrill Lynch data show.

Standard & Poor’s assigned a BB- rating to Gateway Casinos & Entertainment Ltd., three notches below investment grade, with a stable outlook, the agency said yesterday in a statement. S&P gave the firm’s proposed C$340 million sale of secured term loans a BB+ rating, the highest non-investment grade, and its sale of C$170 million in second-lien notes a BB- rating.

“The stable outlook on Gateway stems from our expectation that the company will use its robust discretionary cash flow to reduce debt in the next several years,” Toronto-based S&P analyst Donald Marleau said in the statement.

Canadian corporations have issued C$60 billion in debt this year, more than the C$57.2 billion in all of 2009, and the most since 2007, according to Bloomberg data.

Provincial Bonds

In provincial bond markets, relative yields were unchanged yesterday at 52 basis points, from 53 basis points at the end of last week and 58 on Sept. 30. Yields were 3 percent, little changed from the end of last month. The index has returned 0.07 percent this month, compared with a 0.39 percent loss for Canada’s federal bonds.

The benchmark Canadian 10-year bond’s yield climbed 8 basis points today as the 3.5 percent security due in June 2020 slumped 65 cents to C$105.11.

The benchmark two-year note’s yield touched 1.46 percent, the highest level in a month. The 1.5 percent bond maturing in December 2012 fell 6 cents to C$100.11. The 30-year’s yield rose 4 basis points to 3.50 percent.

Canada’s gross domestic product increased 0.3 percent in August, after a 0.1 percent drop in July, according to the median of 24 forecasts in a Bloomberg News survey. Statistics Canada releases the data tomorrow at 8:30 a.m. in Ottawa.

Bond investors’ expectations for Canadian inflation during the next decade touched 2.16 percent Oct. 25 -- the highest since May -- even as the Bank of Canada’s preferred core measure slowed to a rate of 1.5 percent in September.

Quantitative Easing

Minutes of the last U.S. central bank meeting, released on Oct. 12, increased uncertainty about how much so-called quantitative easing Fed Chairman Ben S. Bernanke might initiate when policy makers meet Nov. 2-3, analysts say.

“Recent moves on U.S. yields have to do with markets paring down expectations for QE2,” Pascal Gauthier, an economist at Toronto-Dominion Bank in Toronto, said via e-mail. “Markets had already priced in large Fed purchases.”

Economic data yesterday showing a bigger-than-forecast increase last month in U.S. new home sales and a report Oct. 26 showing higher-than projected consumer confidence this month may give the Fed reason to scale back on potential quantitative easing.

A further narrowing of the Canada-U.S. 10-year spread is “certainly a possibility,” Gauthier said. “The U.S. market seems to be pricing in $500 billion in QE, whereas we see it coming closer to $400 billion, with an open-ended statement by the Fed to do more as needed.”

QE Estimates

Estimates for the size of the program had ranged from $1 trillion at Bank of America-Merrill Lynch Global Research to $2 trillion at Goldman Sachs Group Inc., with economists at both firms agreeing the Fed will likely begin with a $500 billion plan after its meeting next week.

Yields are also rising faster in the U.S. than in Canada because investments are flowing more quickly into U.S. stocks in anticipation of another round of stimulus, according to Paul Ferley, deputy chief economist at Royal Bank of Canada.

“With the improvement in terms of equity markets, you’re also seeing investors pulling out of fixed income and moving into equities,” Ferley said by phone from Toronto. “You’re seeing more of those flows occurring in the U.S. versus Canada. That’s resulting in more of a rise in U.S. yields.”

The Standard & Poor’s 500 Index has gained 11 percent since Aug. 27, when Bernanke signaled in a speech in Jackson Hole, Wyoming, that the Fed may add more stimulus to the economy through quantitative easing. The Standard & Poor’s/TSX Composite Index, Canada’s primary stock gauge, rose 5.8 percent during that period.

‘Considerable’ Stimulus

Bank of Canada Governor Mark Carney reiterated yesterday the country’s economy has “considerable” stimulus from his 1 percent benchmark interest rate and further moves to tighten policy would be “carefully considered.”

The central bank last week lowered its economic growth forecast for the next five quarters and kept its key lending rate unchanged after three prior increases.

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

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

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