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Sovereign Debt Only Lags Behind Greece, Portugal: Canada Credit

Canadian bonds, the worst performing sovereign-debt market the past three months after Greece and Portugal, may fall further as investors speculate policy makers will raise interest rates as early as June.

Canada’s bonds maturing in a year or more fell 0.9 percent during the last month as investors bet the central bank may begin raising its overnight target rate from a record-low 0.25 percent at its next meeting on June 1.

“The market isn’t sure if the bank will raise by quarter points or half points,” said Sebastien Lavoie, an economist at Laurentian Bank of Canada who expects the rate to rise to 2 percent by year-end. “There is an argument to be made for half-point increases and when the market becomes convinced of that, it will be reflected” in the two-year bond yield.

Bank of Canada Governor Mark Carney this week boosted his forecast for first-quarter growth and dropped a pledge to leave rates unchanged until July unless the inflation outlook changed. Investors are now considering if the central bank may raise its rate faster than a quarter-point at each of its five meetings until the end of the year.

“Short rates reflect an expectation that the bank will start tightening in June and increase in quarter point increments -- attention will now shift to looking for clues the bank might tighten more aggressively” said Mohammed Ahmed, a rates strategist at Canadian Imperial Bank of Commerce in Toronto. “You can expect to see a period of extreme data sensitivity for short-term bonds -- if you have much better-than-expected economic releases, and in particular consumer prices, the market will respond by pushing rates higher.”

Ten-Year Auction

Statistics Canada said today that inflation slowed to 1.4 percent in March, from 1.6 percent the previous month, and the core inflation also decelerated to 1.7 percent from February’s 2.1 percent. Economists expect the overall index to gain 1.6 percent from a year ago and the core measure to advance 2 percent. Core inflation is closely watched by the central bank because it excludes volatile items like gasoline and gives a better sense of trends.

Elsewhere in credit markets, the Canadian government said yesterday it will sell C$3 billion ($3 billion) of 10-year bonds on April 28. The 3.5 percent securities mature in June 2020, the Bank of Canada said in a statement.

New Brunswick sold C$300 million of 4.8 percent bonds maturing in June 2041, doubling its March 29 offering. The sale, which was led by the Royal Bank of Canada, was priced to yield 89 basis points more than the comparable Canadian government bond.

Yield Spread

The extra yield investors demand to own Canada’s provincial bonds instead of government debt widened to 54 basis points yesterday, from 48 basis points on April 12, according to Bank of America Merrill Lynch data.

Canada’s 1.5 percent bond due March 2012 fell 0.7 percent over the last month to C$99.07, pushing its yield up 41 basis points to 2.02 percent.

“Canada is distinguishing itself from the U.S., Europe and the U.K. and a host of others in that it is more readily willing to raise rates,” said Eric Lascelles, chief rates strategist and economist at Toronto Dominion Bank. “The market is in extreme data-dependency mode right now -- there’s an awakening that the bank’s decisions are not pre-ordained and these figures will have some bearings.”

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